Question

You own and manage a pretzel and lemonade concession cart. You decide that you want to sell your products at a NASCAR® race weekend in Loudon, NH. The track charges $1,000 in rent for the entire weekend. Food and beverage costs run about 20% of sales. You have to pay an employee $400 to run the cart over the weekend. You provide incentives of 5% of sales. Your accountant allows you to take $250 in depreciation expenses for this weekend as well. Let’s pretend you use the cart for only one weekend per year (therefore, this one weekend is your annual sales and expenses). The car costs you $1,250 to purchase and you expect to use it for 5 years (with depreciation of $250 per year). Assume a required rate of return of 15%. Question 1 – Find Accounting and Cash Flow Breakeven  If the average lemonade or pretzel sale is $5/each, how many items will you have to sell to reach accounting breakeven?  Accounting Unit Breakeven  Cash Unit Breakeven  How many units do you need to sell cash flow breakeven? (Assume no taxes). Question 2 – Calculate Degree of Operating Leverage You estimate that your sales for the weekend will either be “average” or “great”: • Average: 500 units sold • Great: 750 Units sold Calculate the degree of leverage at AVERAGE and GREAT sales?  Degree of Operating Leverage  = 1 + Fixed Expenses/OCF DOL = 1 + (FC/OCF) Question 3 – Test your answer! From question 2, increase unit sales 10%. Show that your OCF went up by the degree of operating leverage suggested. Example. Say you calculated a DOL of 2.5. An increase in sales of 10% would suggest OCF would increase 25%.

Answer 1

Fixed costs		Variable costs/unit
Rent	1000	F&B(5*20%)	1
Employee salary	400	Incentives(5*5%)	0.25
Total	1400		1.25

1.Cash break-even=Fixed costs/(P-V.c)

1400/(5-1.25)=

373 units

Accounting Break-even=(Fixed costs+Depn.)/(P-V.c)

(1400+250)/(5-1.25)=

440 units

2....DOL=1+(FC/OCF)		3.. Verification Of 2..
DOL at average sales=500 units		When sales is increased by 10% , ie. 500+50=550 units
OCF=((P-V.c)*Qty.-FC)		OCF=((5-1.25)*550)-1400=
ie.((5-1.25)*500)-1400=		662.5
475		ie.increase by 39.5%--3.95*1.10)
DOL at average sales,500 units=		475*(1.395)= 662.5
1+(1400/475)=
3.95

DOL at Great sales,750 units=		When sales is increased by 10% , ie. 750+75=825 units
OCF=((P-V.c)*Qty.-FC)		OCF=((5-1.25)*825)-1400=
ie.((5-1.25)*750)-1400=		1693.75
1412.5		ie.increase by 19.9%--1.99*1.10)
DOL at Great sales,750 units=		1412.5*(1.199)= 1693.59
1+(1400/1412.5)=
1.99