Question

A firm’s product sells for $12 per unit. The unit variable cost is $8. The operating fixed costs total $100,000 per year. The firm pays $20,000 interest and $3,000 preferred dividends each year. The tax rate for this firm is 40%.

1. What is the firm’s operating breakeven point (rounded to the whole unit)? Select one:

a. 25,000 units

b. 30,000 units

c. 45,000 units

d. 50,000 units

e. None of the above

2. What is the DOL at 50,000 units per year (rounded to the first decimal place)?Select one:

a. 2.0

b. 2.5

c. 4.5

d. 5.0

e. None of the above

3. What is the DFL at 50,000 units per year (rounded to the first decimal place)? Select one:

a. 0.3

b. 1.3

c. 2.3

d. 3.3

e. None of the above

4. What is the DTL at 70,000 units per year (rounded to the first decimal place)?Select one:

a. 1.1

b. 1.5

c. 1.8

d. 2.3

e. None of the above

Answer 1

Answer 1.

Contribution margin per unit = Selling price per unit - Variable cost per unit
Contribution margin per unit = $12 - $8
Contribution margin per unit = $4

Operating breakeven point = Operating fixed costs / Contribution margin per unit
Operating breakeven point = $100,000 / $4
Operating breakeven point = 25,000 units

Answer 2.

Contribution margin = Contribution margin per unit * Number of units
Contribution margin = $4 * 50,000
Contribution margin = $200,000

Operating income = Contribution margin - Operating fixed costs
Operating income = $200,000 - $100,000
Operating income = $100,000

Degree of operating leverage = Contribution margin / Operating income
Degree of operating leverage = $200,000 / $100,000
Degree of operating leverage = 2.0

Answer 3.

Operating income = Contribution margin - Operating fixed costs
Operating income = $200,000 - $100,000
Operating income = $100,000

Taxable income = Operating income - Interest expense
Taxable income = $100,000 - $20,000
Taxable income = $80,000

Degree of financial leverage = Operating income / Taxable income
Degree of financial leverage = $100,000 / $80,000
Degree of financial leverage = 1.3

Answer 4.

Contribution margin = Contribution margin per unit * Number of units
Contribution margin = $4 * 70,000
Contribution margin = $280,000

Operating income = Contribution margin - Operating fixed costs
Operating income = $280,000 - $100,000
Operating income = $180,000

Taxable income = Operating income - Interest expense
Taxable income = $180,000 - $20,000
Taxable income = $160,000

Degree of total leverage = Contribution margin / Taxable income
Degree of total leverage = $280,000 / $160,000
Degree of total leverage = 1.8