Question

OPERATING LEVERAGE
Riyadh Company manufactures a complete line of electronics. The average selling price for the various products is SAR 715. The associated variable cost is SAR 475 per unit. Fixed costs for the firm averay SAR 225,000 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 (i.e., the ratio of the percent change in EBIT divided by the corresponding percent change in sales) for a production and sales level of 3,000 units for the firm? (Calculate to three decimal places.)
d. What will be the projected effect ono earnings before interest and taxes if the firm's sales level should increase by 17 percent from the volume noted in part c.
Solution:
DATA
Avg selling price		715
Avg Variable Cost		475
Fixed costs		225,000
A)
Breakeven pt in units =
B)
Sales volume =
C)
Sales level
Operating leverage =
D)
Sales increase
EBIT increase =

Answer 1

Answer a.

Selling Price = SAR 715
Variable Cost per unit = SAR 475

Contribution Margin per unit = Selling Price - Variable Cost per unit
Contribution Margin per unit = SAR 715 - SAR 475
Contribution Margin per unit = SAR 240

Breakeven Point in units = Fixed Costs / Contribution Margin per unit
Breakeven Point in units = SAR 225,000 / SAR 240
Breakeven Point in units = 938 units

Answer b.

Selling Price = SAR 715
Variable Cost per unit = SAR 475

Contribution Margin Ratio = (Selling Price - Variable Cost per unit) / Selling Price
Contribution Margin Ratio = (SAR 715 - SAR 475) / SAR 715
Contribution Margin Ratio = 33.57%

Breakeven Point in dollar = Fixed Costs / Contribution Margin Ratio
Breakeven Point in dollar = SAR 225,000 / 0.3357
Breakeven Point in dollar = SAR 670,241

Answer c.

Sales Level = 3,000 units
Selling Price = SAR 715
Variable Cost per unit = SAR 475
Fixed Costs = SAR 225,000

Contribution Margin per unit = Selling Price - Variable Cost per unit
Contribution Margin per unit = SAR 715 - SAR 475
Contribution Margin per unit = SAR 240

Contribution Margin = Sales Level * Contribution Margin per unit
Contribution Margin = 3,000 * SAR 240
Contribution Margin = SAR 720,000

Net Operating Income = Contribution Margin - Fixed Costs
Net Operating Income = SAR 720,000 - SAR 225,000
Net Operating Income = SAR 495,000

Degree of Operating Leverage = Contribution Margin / Net Operating Income
Degree of Operating Leverage = SAR 720,000 / SAR 495,000
Degree of Operating Leverage = 1.45

Answer d.

% Change in sales = 17%
Degree of Operating Leverage = 1.45

Degree of Operating Leverage = % Change in EBIT / % Change in Sales
1.45 = % Change in EBIT / 17%
% Change in EBIT = 24.65%