Question

Healthy Foods Inc. sells 40-pound bags of grapes to the military for $15 a bag. The fixed costs of this operation are $105,000, while the variable costs of grapes are $.20 per pound.

a. What is the break-even point in bags?
  

b. Calculate the profit or loss (EBIT) on 14,000 bags and on 40,000 bags.
  

c. What is the degree of operating leverage at 28,000 bags and at 40,000 bags? (Round your answers to 2 decimal places.)
  

d. If Healthy Foods has an annual interest expense of $11,000, calculate the degree of financial leverage at both 28,000 and 40,000 bags. (Round your answers to 2 decimal places.)
  

e. What is the degree of combined leverage at both 28,000 and 40,000 bags? (Round your answers to 2 decimal places.)

Answer 1

a. Break even point (In Bags) = Fixed Cost / Contribution per bag.
Where contribution per bag = $15-$(.2*40) = $7
Thus, Break even Point = $105000/7 = 15000 Bags
Ans : The breakeven point is 15000 bags.

b. Profit on 14000 bags = Contribution on 14000 bags - Fixed Cost.
We have already calculated per bag contributon as $7.
Thus , profit on 14000 bags = $(14000*7)-105000
= Loss of $7000
Similarly Profit on 40000 bags = $(40000*7)-105000
= Profit of $ 175000.

c. We will use the following table to calculate the Operating Leverage at difference sales levels :

		Sceneio 1	Scenerio 2
	No of Bags	28000	40000
	Contribution bag	7	7
	Total contribution	196000	280000
Less	Fixed Cost	105000	105000
	Operating Profit	91000	175000

We know now, Operating Leverage = Contribution / Operating Profit.
Degree of Operating Leverage (at 28000 bags) = 91000/196000 = 0.46
Degree of Operating Leverage (at 40000 bags) = 175000/280000 = 0.625

d. To calculate degree of Financial Leverage, we use the following table :

		Sceneio 1	Scenerio 2
	No of Bags	28000	40000
	Contribution bag	7	7
	Total contribution	196000	280000
Less	Fixed Cost	105000	105000
	Operating Profit	91000	175000
Less	Interest	11000	11000
	Net Profit	80000	164000

We know,
Degree of Financial Leverage = Profit before Interest / Profit after Interest
Thus using data from above table,
Degree of Financial Leverage (at 28000 bags) = 91000/80000 =1.1375
Degree of Financial Leverage (at 40000 bags) = 175000/164000 = 1.067

e. We know,
Degree of combined Leverage = Operating Leverage * Financial Leverage.
Thus using values as already calculated,
Total Leverage(at 28000 bags) = 0.46 * 1.1375 = 0.528
Total Leverage (at 40000 bags) = 0.625 * 1.067 = 0.6669.

Thus all parts to the question are answered. Thank you.