Question

Russell Preston delivers parts for several local auto parts stores. He charges clients 0.85 per mile driven. Russell has determined that if he drives 3,000 miles in a month, his average operating cost is $0.75 per mile. If he drives 5,000 miles in a month, his average operating cost is $0.55 per mile. Russell has used the high-low method to determine that his monthly cost equation is: total cost = $1,320.00 + $0.25 per mile.        

Required:
1. Determine how many miles Russell needs to drive to break even.



2. Assume Russell drove 2,600 miles last month. Without making any additional calculations, determine whether he earned a profit or a loss last month.

	Loss
	Profit

3. Determine how many miles Russell must drive to earn $1,500.00 in profit.

  

4-a. Prepare a contribution margin income statement assuming Russell drove 2,600 miles last month. (Enter your answers rounded to 2 decimal places.)

  

4-b. Use the above information to calculate Russell’s degree of operating leverage. (Round your answer to the 2 decimal places.)

Answer 1

• All working forms part of the answer
• Requirement 1

A	Price charged	$                       0.85	per mile
B	Variable cost	$                       0.25	per mile
C = A - B	Contribution margin	$                       0.60	per mile
D	Fixed Cost	$              1,320.00	per month
E = D/C	Miles needed to Break Even	2,200	miles

• Requirement 2

--PROFIT, because 2600 miles is MORE than the Break Even miles of 2,200

• Requirement 3

A	Target profits	$              1,500.00
B	Fixed Cost	$              1,320.00
C = A+B	Total Contribution required	$              2,820.00
D	Contribution margin per mile	$                       0.60
E = C/D	Miles needed to earn target profit	4,700 miles

• Requirement 4 a

Contribution margin Income Statement		Working
Revenue	$              2,210.00	[2600 miles x $ 0.85]
Variable cost	$                  650.00	[2600 miles x $ 0.25]
Contribution margin	$              1,560.00	[2210 - 650]
Fixed Cost	$              1,320.00
Net Income	$                  240.00	[1560 - 1320]

• Requirement 4 b

A	Contribution margin	$              1,560.00
B	Net Income	$                  240.00
C = A/B	Degree of Operating Leverage	6.50