Question

17. As the financial manager for a manufacturing firm, you have constructed the following partial pro forma income statement for the next fiscal year.

Sales $15,700,000
Variable costs 7,600,000
Revenue before fixed costs 8,100,000
Fixed costs 4,500,000
EBIT 3,600,000
Interest expenses 1,400,000
Earnings before taxes 2,200,000
Taxes (40%) 880,000
Net income $1,320,000

a. What is the degree of operating leverage at this level
of output? 2.25
b. What is the degree of financial leverage? 1.64
c. What is the degree of combined leverage? 3.69
d. What is the break-even point in sales dollars for the
firm?
e. If the average unit cost is $11.25, what is the breakeven
point in units?

Answer 1

Degree of operating leverage = sales - variable cost / sales - variable cost - fixed cost

= $15,700,000 - 7,600,000 / $15,700,000 - 7,600,000 - 4,500,000

= 2.25

Degree of financial leverage = Earnings before interest and tax / earnings before tax

= 36,00,000 / 22,00,000

= 1.64

Combined leverage = Operating leverage * financial leverage

= Contribution/ Earnings before interest & tax * Earnings before interest and tax / earnings before tax

= 81,00,000/36,00,000*36,00,000/22,00,000

On cross multiplying,

= 81,00,000/22,00,000

= 3.68

(Contribution = sales - variable cost)

Contribution margin = contribution / sales *100 = 51.59%

average cost per unit = $ 11.25

Therefore, selling price per unit = $11.25/48.41% = $ 23.24

contribution per unit = $23.24 * 51.59% = $11.99

Break even sales (Volume) = Total fixed cost / contribution margin

= $45,00,000 / 51.59%

= $87,22,621

Break even sales (Units) = Total fixed cost / contribution per unit

= $4,500,000 / $ 11.99

= 375,313 units