In: Finance
During the most recent fiscal year, Medical Electronics Corporation sold 2,560,000 health monitoring devises at $60 per unit. Variable operating costs were 60% of sales ($36 per unit), while fixed operating costs were $12,288,000. The cost of outstanding debt (interest expense) was $4,152,000. Medical Electronics Corporation’s tax rate is 30%. The company does not sell any other product. (PLEASE SHOW YOUR WORK).
a) Construct Medical Electronics Corporation’s income statement for the most recent fiscal year (complete the following table).
Sales |
|
Less: Variable operating costs |
|
Fixed operating costs |
|
Earnings before interest and taxes (EBIT) |
|
Less: Interest expense |
|
Earnings before taxes (EBT) |
|
Less taxes (30%) |
|
Earnings after taxes (EAT) |
b) Compute the degree of operating leverage (DOL)
c) Interpret the calculated DOL.
a | $ | ||
Sales | 153,600,000 | ||
Less: Variable operating costs | 92,160,000 | ||
Contribution | 61,440,000 | ||
Fixed operating costs | 12,288,000 | ||
Earnings before interest and taxes (EBIT) | 49,152,000 | ||
Less: Interest expense | 4,152,000 | ||
Earnings before taxes (EBT) | 45,000,000 | ||
Less taxes (30%) | 13,500,000 | ||
Earnings after taxes (EAT) | 31,500,000 | ||
b | Degree of operating leverage (DOL) | ||
Contribution Margin / Operating income | |||
61440000 / 49152000 | 1.25 | ||
c | The Degree of Operating Leverage (DOL) is the leverage ratio that sums up the effect of an amount of operating leverage on the company’s earnings before interests and taxes (EBIT). | ||
. If the degree of operating leverage is high, it means that the earnings before interest and taxes would be unpredictable for the company, even if all the other factors remain the same. |