Question

​(Operating leverage​) The Quarles Distributing Company manufactures an assortment of cold air intake systems for​ high-performance engines. The average selling price for the various units is ​$500 . The associated variable cost is ​$400 per unit. Fixed costs for the firm average $ 200 comma 000 annually. a. What is the​ break-even point in units for the​ company? b. What is the dollar sales volume the firm must achieve to reach the​ break-even point? c. What is the degree of operating leverage for a production and sales level of 5 comma 000 units for the​ firm? (Calculate to three decimal​ places.) d. What will be the projected effect on earnings before interest and taxes if the​ firm's sales level should increase by 50 percent from the volume noted in part ​(c​)?

Answer 1

Question a:

Average Selling Price = $500

Average Variable Cost = $400

Marginal Cost = Average Selling Price - Average Variable Cost = $500 - $400 = $100

Average Fixed Costs = $200,000

Break Even Point In Units = Average Fixed Costs / Marginal Cost

= $200,000 / $100

= 2,000 units

Therefore, Break Even point is 2,000 units

Question b:

Dollar Sales volume = Break Even Point in units * Average Sales Price

= 2,000 units * $500

= $1,000,000

Dollar Sales Volume is $1,000,000

Question c:

Contribution Margin = Sales in units * (Average Sales price - Average Variable Price)

= 5,000 units * ($500 - $400)

= $500,000

Operating Income = Contribution margin - Average Fixed Costs

= $500,000 - $200,000

= $300,000

Degree of Operating Leverage = Contribution margin / Operating Income

= $500,000 / $300,000

= 1.666667

Therefore, Degree of Operating leverage is 1.67

Question d:

Sales = 5000 units * (1+50%) = 7,500 units

Projected EBIT = Sales units * (Average Sales Price - Average variable price ) - Fixed Costs

= 7,500 * ($500 - $400) - $200,000

= $750,000 - $200,000

= $550,000

Change in EBIT = Projected EBIT - Current EBIT = $550,000 - $300,000 = $250,000

% change in EBIT = Change in EBIT / Current EBIT = $250,000 / $300,000 = 0.8333333 = 83.33%