Question

The Sterling Tire Company’s income statement for 20XX is as follows: STERLING TIRE COMPANY Income Statement Year ended December 31, 20XX Sales (30,000 tires at $45 each) $ 1,350,000 Less: Variable costs (30,000 tires at $20) 600,000 Contribution margin 750,000 Less: Fixed costs 600,000 Earnings before interest and taxes (EBIT) 150,000 Interest expense 75,000 Earnings before taxes (EBT) 75,000 Income tax expense (30%) 22,500 Earnings after taxes (EAT) $ 52,500 Given this income statement, compute the following: a. Degree of operating leverage. (Round the final answer to 2 decimal places.) DOL X b. Degree of financial leverage. (Round the final answer to 2 decimal places.) DFL X c-1. Degree of combined leverage. (Do not round the intermediate calculations. Round the final answer to 2 decimal places.) DCL X c-2. Using your answers to a. and b. calculate the percentage increase in EBIT and EBT from a 20 percent increase in sales volume. (Do not round the intermediate calculations. Round the final answers to 2 decimal places.) EBIT % EBT % c-3. Does financial or operating leverage have the greater impact? DOL DFL d. Break-even point in units. (Round the final answer to the nearest whole number.) Break-even point tires e. Break-even point considering the interest expense as a fixed cost. Break-even point tires Next Visit question mapQuestion 13 of 30 Total 13 of 30 Prev

Answer 1

(a) Degree of Operating leverage:-

Formula = [Quantity * (Price - Variable Cost per Unit)] / Quantity * (Price - Variable Cost per Unit) - Fixed Operating Costs

= [30,000 * (45-20)] / 30,000 * (45-20) - 6,00,000

= 7,50,000 / 1,50,000

Operating Leverage = 5

(b) Degree of Financial Leverage:-

Formula = EBIT / EBIT - Interest

= 1,50,000 / 1,50,000 - 75,000

= 2

(c) Degree of combined Leverage:-

Formula = Degree of operating leverage * Degree of financial leverage

= 5 * 2

= 10

(d) If sales quantity increase by 20%

Particulars	Current situation	After 20% increase
Sales(Unit)	30,000	36,000
Salling price per unit	45	45
total sales price	13,50,000	16,20,000
Less: Variable Cost @20 PU	(6,00,000)	(7,00,000)
Contribution	7,50,000	9,20,000
Less:- Fixed cost	(6,00,000)	(6,00,000)
EBIT	1,50,000	3,20,000
Interest Expenses	(75,000)	(75,000)
EBT	75,000	2,45,000

% Change in EBIT = [(3,20,000 / 1,50,000)*100] - 100 = 113%

% change in EBT = [(2,45,000 / 75,000)*100] - 100 = 226%