Question

Companies A and B operate in the same field, for which the following pieces of information are given in the table below

	Company A	Company B
Q (products sold)	150,000	190,000
P (price per product)	$80	$70
FC (fixed cost)	$550,000	$850,000
VC (variable cost per product)	$45	$35
EBIT	$2,500,000	$4,200,000
I (interest expenses)	$140,000	$750,000

Find the following:

a. Degree of operating leverage for both companies, and explain your answers.

b. Degree of financial leverage for both companies, and explain your answers.

c. Degree of total leverage for both companies.

d. Which company has higher business risk, and financial risk?

e. How many product each company should sell to cover its operating expenses?

Answer 1

ans a) degree of operating leverage = Q(P-V)/Q(P-V)-F

COMPANY A = 150,000(80-45)/150,000(80-45)-550,000

=5,250,000/4,700,000

=1.12

COMPANY B =190,000(70-35)/190,000(70-35)-850,000

=6,650,000/5,800,000

=1.15

ans b)degree of financial leverage = EBIT/EBIT- interest

COMPANY A=2,500,000/2,500,000-140,000

=1.06

COMPANY B=4,200,000/4,200,000-750,000

=1.22

ansc) degree of total leverage = degree of financial leveragex degree of operating leverge

COMAPANY A = 1.12x1.06

=1.19

COMPANY B=1.15x1.22

= 1.4

ansd) comapany which have the higher business risk is the one having higher operating leverage=COMPANY B

company which have the higher financial risk is the one having higher financial leverage = COMPANY B

anse)breakeven quantity = fixed cost+interest expenese/(price-variable cost)

COMPANY A=550,000+140,000/(80-45)

=19,715 quantity

COMAPNY B=850,000+750,000/(70-35)

=45,715 quantity

i hope that clears thank you