Question

Dr. Armstrong performs a certain cosmetic dental procedure at her dentistry clinic. Her monthly fixed operating costs are $12,000, while her after-tax operating income is $8,000 when she performs 200 such procedures in a month. Dr. Armstrong's before-tax operating income is subject to a marginal tax rate of 60%.

Required:

a) What is the margin of safety percentage for Dr. Armstrong, assuming she performs 200 procedures?
b) What is the degree of operating leverage for Dr. Armstrong, again assuming she performs 200 procedures?

Answer 1

a. Calculation of Margin of Safety Percentage for Dr. Armstrong, assuming she performs 200 Procedures:

For Level of 200 Procedures

Monthly Fixed Operating Costs = $12,000

After Tax Operating Income = $8,000

Marginal Tax Rate = 60%

Before-Tax Operating Income = (After Tax Operating Income / 40) * 100

Before-Tax Operating Income = ($8,000 / 40) * 100

Before-Tax Operating Income = $20,000

Contribution Margin = Before-Tax Operating Income + Monthly Fixed Operating Costs

Contribution Margin = $20,000 + $12,000 = $32,000

Contribution Margin Per Procedure = Contribution Margin / No. of Procedures

Contribution Margin Per Procedure = $32,000 / 200 Procedures = $160

Break-Even Point = Monthly Fixed Operating Costs / Contribution Margin Per Procedure

Break-Even Point = $12,000 / $160

Break-Even Point = 75 Procedures

Margin of Safety Percentage = [(Current Activity Level – Break-Even Point) / Current Activity Level] *100

Margin of Safety Percentage = [(200 Procedures – 75 Procedures) / 200 Procedures] *100

Margin of Safety Percentage = 62.5%

b. Calculation of Degree of Operating Leverage for Dr. Armstrong, assuming she performs 200 Procedures:

Degree of Operating Leverage = Contribution Margin / Before-Tax Operating Income

Degree of Operating Leverage = $32,000 / $20,000

Degree of Operating Leverage = 1.6 Times