Question

Consider a four-year project with the following information: initial fixed asset investment = $450,000; straight-line depreciation to zero over the four-year life; zero salvage value; price = $26; variable costs = $16; fixed costs = $140,000; quantity sold = 74,000 units; tax rate = 34 percent.

What is the degree of operating leverage at the given level of output? (Do not round intermediate calculations. Round your answer to 4 decimal places, e.g., 32.1616.) Degree of operating leverage=

What is the degree of operating leverage at the accounting break-even level of output? (Do not round intermediate calculations. Round your answer to 4 decimal places, e.g., 32.1616.) Degree of operating leverage=

Answer 1

Initial Investment = $450,000
Useful Life = 4 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $450,000 / 4
Annual Depreciation = $112,500

Contribution Margin per unit = Price per unit - Variable Cost per unit
Contribution Margin per unit = $26 - $16
Contribution Margin per unit = $10

Answer a.

Operating Cash Flows = [Units Sold * Contribution Margin per unit - Fixed Costs] * (1 - Tax Rate) + Tax Rate * Depreciation
Operating Cash Flows = [74,000 * $10 - $140,000] * (1 - 0.34) + 0.34 * $112,500
Operating Cash Flows = $600,000 * 0.66 + 0.34 * $112,500
Operating Cash Flows = $434,250

Degree of Operating Leverage = 1 + Fixed Costs / Operating Cash Flows
Degree of Operating Leverage = 1 + $140,000 / $434,250
Degree of Operating Leverage = 1.3224

Answer b.

Accounting Breakeven Quantity = (Fixed Costs + Depreciation) / Contribution Margin per unit
Accounting Breakeven Quantity = ($140,000 + $112,500) / $10
Accounting Breakeven Quantity = 25,250

Operating Cash Flows = [Units Sold * Contribution Margin per unit - Fixed Costs] * (1 - Tax Rate) + Tax Rate * Depreciation
Operating Cash Flows = [25,250 * $10 - $140,000] * (1 - 0.34) + 0.34 * $112,500
Operating Cash Flows = $112,500 * 0.66 + 0.34 * $112,500
Operating Cash Flows = $112,500

Degree of Operating Leverage = 1 + Fixed Costs / Operating Cash Flows
Degree of Operating Leverage = 1 + $140,000 / $112,500
Degree of Operating Leverage = 2.2444