Question

The Andrea S. Fault Seismometer Company is an all-equity-financed firm. It earns
monthly, after taxes, $24,000 on sales of $880,000. The tax rate of the company is 40 per-
cent. The company’s only product, “The Desktop Seismometer,” sells for $200, of which
$150 is variable cost.
a. What is the company’s monthly fixed operating cost?
b. What is the monthly operating break-even point in units? In dollars?
c. Compute and plot the degree of operating leverage (DOL) versus quantity produced
and sold for the following possible monthly sales levels: 4,000 units; 4,400 units;
4,800 units; 5,200 units; 5,600 units; and 6,000 units.
d. What does the graph that you drew (see Part (c)) – and especially the company’s DOL
at its current sales figure – tell you about the sensitivity of the company’s operating
profit to changes in sales?

2. What would be the effect of the following on the break-even point of the Andrea S. Fault
Company (Problem 1)?
a. An increase in selling price of $50 per unit (assume that sales volume remains constant)
b. A decrease in fixed operating costs of $20,000 per month
c. A decrease in variable costs of $10 per unit and an increase in fixed costs of $60,000
per month


question 2

Answer 1

Question 2) in the given case we can compute the following things:

sales = $880000 and selling price per piece is $200. Hence nuber of sold units will be 4400 units.

Sales	880000
-Veriable cost(4400*150)	660000
Contribution(880000-660000)	220000
-profit before tax*	40000
Fixed cost	180000

By this we can compute the PVR

PVR = Contribution/ sales

PVR = 220000/880000 = 25%

* Profit before tax = profit after tax + tax

profit before tax = 24000 + 40% profit before tax

therefore, profit before tax = $40000

a) An increase in selling price of $50 per unit:

Break even point is that level of sales at which contribution is exactly equal to the fixed cost.

hence new contribution is $180000

Since new sales price is $250 now

From above PVR ratio is 25%

therefore break even sales is equal to New contribution divided by the PVR of the company

Break even sales = 180000/25% = $720000

Break even vollume = 720000/250 = 2880 units.

b) A decrease in fixed operating cost of $20000 per month

This gives a new contribution of $160000

hence like above, Break even sales = 160000/25% = $640000

Break even sales volume= 640000/200 = 3200 units

c) A decrease in variable cost of $10 per unit and an increase in fixed cost of $60000 per month

In this case the PVR will change since change of variable cost will result in new contribution. Hence first we have to calculate te new PVR

Sales	880000
- variable cost (4400*140)	616000
Contribution	264000

PVR = 264000/880000 = 30%

Now it is also given that fixed cost is increased by $60000. hence new fixed cost is $240000

which means at break even point contribution will be $240000

Break even sales = 240000/30% = $800000

Break even sales volume = 800000/200 = 4000 units.