Question

Show all your work (use of formula, etc.) in solving the problems. You still need to show your work even if you use the financial calculator to get the answers. (Please show all work and do not use excel)

2. At an output level of 2,000 units, you calculate that the degree of operating leverage is 3. Fixed costs are $35,000. (a) If output rises to 2,500 units, calculate the percentage change in OCF, new OCF and new DOL. (b) If output falls to 1,500 units, calculate the percentage change in OCF, new OCF and new DOL. (hint: start by finding the OCF at 2,000 units using DOL equation of 1+ FC/OCF)

Answer 1

Given:
1	Output Level or Q 0	2000	Units
2	Degree of Operating Leverage (DOL)	3
3	Fixed Costs	35000
4	DOL formula:

DOL =

(1+Fixed Costs(FC))/ Operating Cash Flow (OCF)

i)	To calculate OCF at Output level of 2,000 units using the DOL formula
=>	3=(1+35,000)/OCF
=>	3* OCF = (1+35,000)
=>	OCF = (1+35,000)/3
=>	Therefore, OCF at Output level of 2,000	11,667
ii)	% change in OCF, OCF and DOL for change in output level from 2000 to 2500
Note	The DOL formula can also be expressed as the percentage change in OCF divided by the percentage change in quantity sold, i.e.,
	DOL = % change OCF / % Change in Q
=>	DOL * % Change in Q = % Change in OCF
Given,
	New quantity or Q1	2500
	Change in quantity ( Q1 - Q0) : 2500-2000	500
	Therefore, % change in Quantity ((2500-2000)/2000)*100	25%
	Original DOL	3
	Fixed Costs	35000
	% change OCF = DOL * % Change in Q
=>	% change in OCF = 3*(25%)
=>	% change in OCF	0.75
Answer	% change in OCF	75.00%
Answer	Therefore, New OCF = 11,667*(1+72.5%)	$20,417.25

	New DOL :
=>	(1+Fixed Cost)/ OCF
=>	DOL = (1+35000) /20,417.25
=>	DOL = 35001/20,417.25
Answer	New DOL =	1.714

iii)	% change in OCF, OCF and DOL for change in output level from 2000 to 1500
Note	The DOL formula can also be expressed as the percentage change in OCF divided by the percentage change in quantity sold, i.e.,
	DOL = % change in OCF / % change in Q
=>	DOL * % change in Q = % change in OCF
Given,
	New quantity or Q2	1500
	Change in quantity ( Q2 - Q0) : 1500-2000	-500
	Therefore, % change in Quantity ((1500-2000)/2000)*100	-25%
	Original DOL	3
	Fixed Costs	35000
	% change in OCF = DOL * % change in Q
=>	% change in OCF = 3*(1-25%)
=>	% change in OCF	-0.75
Answer	% change in OCF	-75%
Answer	Therefore, New OCF = 11,667*(1-75%)	2,916.75
	New DOL :
=>	(1+Fixed Cost)/ OCF
=>	DOL = (1+35000) /2916.75
=>	DOL = 35001/ 2,916.75
Answer	New DOL = 12