Question

(a) Red Sunset Berhad manufactures mobile phones and wants to add a new model to its
current line of products. The firm has estimated that the new phone’s selling price will
be RM80 and that variable costs would represent 65% of the sale price. Fixed operating
costs are estimated to be RM15million and the firm’s marginal tax rate is expected to
remain at 35%. The firm also has forecasted that interest expenses associated with the
new chip will reach RM5million. The firm has 5million of common shares outstanding
and forecasts a total preferred dividend payment of RM200,000 for the next year. If Red
Sunset Co. expects to sell 1million units of the new phone, then:

(i) Create an income statement with the previous information.

(ii) Calculate the operating break-even point in both units and dollars.

(iii) How many units would Red Sunset Co. need to sell in order to achieve earnings,
before interest and taxes of RM2million?

(iv) Calculate the degree of operating, financial, and combined leverage.

Answer 1

First, we will pen down all the available information:

Sales(in units)=1000,000 units

Selling Price=RM80.

So,Sales Amount=RM(1000,000*80)=RM80,000,000.

Variable Cost=65% of Sales Price i.e., RM(80,000,000*65/100)

VC=RM52000,000

Fixed Cost=RM15000,000

Tax rate=35%

Interest Expense=RM5000,000

Common shares outstanding=5000,000

Preference Dividend Forecast=RM2000,00

1.)Refer below:

Contribution:=(E4-E5)

EBIT:=(E6-E7)

Tax=(E10*I5)

EAT:=(E10-E11)

2.) Operating Break even point

is the point where, contribution is just equal to the fixed cost and the EBIT is 0.i.e. it should be equal to RM 15000,000. So, given contribution of 15000,000

Let Break even sales in units be x

Contribution=Sales-Variable cost

15000,000=80x-52*x

28x=15000,000

x=535714 units

Break even Sales=535714 units

3.) In order to earn an EBIT OF RM2000,000,the company needs to sell:

Let sales in units be x.

EBIT=Sales-Variable Cost-Fixed Cost

2000,000=80x-52x-15000,000

28x=2000,000-15000,000

28x=17000,000

x=607143 units

In order to earn an EBIT OF RM2000,000,the company needs to sell 607143 units.

4.) Refer above table DOL==(E6/E8)

DFL(Degree of Financial Leverage)

EBIT/EBT-(PD/1-t)

PD/(1-t) {=J8/(1-I5)}
EBT-(PD/1-t) {=E10-E19}
DFL {=E8/E20}

DCL=DOL*DFL