Question

A new business has developed its preliminary business model.   It expects to incur BOTH fixed operating and financial costs; and the model projects Year 1 Sales of $650,000 (but team members think that Sales could be as low as $500,000 or as high as $900,000). The owners want to know what will happen to profits if the model Sales projection is incorrect. The primary concern is Sales less than $650,000 given the substantial fixed costs the model accepts. The Year 1 proforma Income Statement is as follows:

Sales                                                             650,000                                                                                                                            

Variable Expense                                   357,500

Gross Profit                                              292,500

Fixed Expenses                                       185,000

EBIT                                                               107,500

Less: Fixed Financial Expenses     57,500

Income                                                       50,000

Note: Ignore Depreciation and Taxes

1. Given the company’s projected Sales and its expense structure, what Degree of Operating Leverage (DOL) is the company willing to accept? (2 points)

2. Given the fixed financial costs in the company model, by what % will Income change for each 1% deviation in EBIT? (3 points)

3. If actual sales are $520,000, by what PERCENTAGE (%) will Income decrease under the company’s present financial model? (Make sure you answer the correct question.)(3 points)

4. What is the company’s Survival Breakeven Sales Volume? (2 points)

Answer 1

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