Question

OceanGate sells external hard drives for $280 each. Its total fixed costs are $30 million, and its variable costs per unit are $230. The corporate tax rate is 30%. If the economy is strong, the firm will sell 2 million drives, but if there is a recession, it will sell only half as many.

a. What is the firm's degree of operating leverage (defined as the ratio of the percent change in EBIT to the percent change in sales) in going from a recession to a strong economy?

Degree of operating leverage            

b. If the economy enters a recession, what will be the firm’s after-tax profit? (Enter your answer in millions.)

After-tax profit   

Answer 1

Selling Price = $280

Variable Cost = $230

Contribution Per unit = $50

Total fixed cost = $30,000,000

Break even sales = $30,000,000/$50 = 600,000 units

Profit after tax incase firm has recession = $14,000,000

	Recession	Strong	% Change
No of units sold	$                  1,000,000	$                  2,000,000
Sales	$             280,000,000	$             560,000,000	100
Contribution per unit	$                                50	$                                50
Total contibution	$               50,000,000	$             100,000,000
Fixed Costs	$               30,000,000	$               30,000,000
EBIT	$               20,000,000	$               70,000,000	250
Tax @ 30%	$                  6,000,000	$               21,000,000
PAT	$               14,000,000	$               49,000,000
Degree of operating levarage	% Change in EBIT
	% Change in Sales
	= 250/100
	"= 2.5