Question

Halla Corporation produces and sells bottled water. The bottled water produced by the company is sold for 500 won per bottle, and the variable cost of producing and selling a bottle of bottled water is 300 won. Meanwhile, the fixed cost incurred in facility investment for the production and sale of the bottled water is 10 million won. Halla Corp. uses 40 million won in debt with an interest rate of 10 percent. Answer the following question.

1. Halla Corporation's sales volume this year is 200,000 bottles. Get a sales guidance at the current level of sales and explain its meaning.

2. Get a financial leveraged map at the current level of sales and explain its meaning.

3. Find a combined leveraged map at the current level of sales and explain its meaning.

(NO CALCULATE FOR DOLLAR PLEASE.) (1 WON=1, 1,000 WON=1,000)

Answer 1

Given,

Sales Volume = 200,000 Bottles

Selling Price per Bottled Water = 500 won

Variable cost per Bottled water = 300 won

Fixed cost Incurred = 10 million won

Debt = 40 million won

Interest Rate = 10%

Interest Amount = 40 million*10% = 4 million won

Q1.Calculation of Earnings before Tax(EBT):

Sales(sales volume*selling price) = 100000000 won

Less :Variable Cost(sales volume*Variable cost per bottled water) = ( 60000000 won)

Contribution   = 40000000 won

Less : Fixed cost = 10000000 won

Earning before Interest and Tax(EBIT) = 30000000 won

Less : Interest @ 10% = 4000000 won

Earnings before Tax(EBT)     = 26000000 won

Degree of Operating Leverage = Contribution / EBIT

= 400000000 won / 300000000 won

   = 1.33

Degree of Operating Leverage of 1.33 means a change in 1% of sales results in a change of 1.33% of operating profit. It is ideal to maintain a positive degree of operating leverage by having a lower variable cost. Halla Corporation is required to maintain high volume of sales to cover Fixed costs.

Q 2.Calculation of Financial Leverage

Degree of Financial Leverage = EBIT / EBT

= 30000000 won / 26000000 won

= 1.154

A financial leverage of 1.154 means a change in 1% of operating Income(EBIT) results in a change of 1.154% of Earning before Tax(Net Profit) and a higher Financial leverage i.e. greater than 1 indicates the risk of Halla Corporation w.r.t repayment of Interest associated with the Debt. A slight change in the leverage ratio may result in financial distess and leads to Bankruptcy of the Business.These ratio is having the effect on the volatality of earning and a volatility in the stock price of the Halla Corporation.

Q3. Calculation of Combined Leverage

Degree of Combined Leverage = contribution / EBT

= 400000000 / 26000000

= 1.538  

A Degree of combined Leverage combines the effect of degree of operating leverage and degree of financial leverage i.e. a 1% change in sales results in 4.538% change in Net profit(EBT) of Halla Corporation.A combined leverage shows the overall company performance w.r.t sales. A positive Leverage i.e.greater than 1 shows that the company is performing more than Break even and making profits after deducting all variable , fixed Expenses and repayment of Interest on the Debt borrowed.