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Sales $3,000,000 Operating costs (excluding depreciation) 1,500,000 Gross margin $1,500,000 Depreciation 500,000 EBIT $1,000,000 Interest 500,000...

Sales $3,000,000

Operating costs (excluding depreciation) 1,500,000

Gross margin $1,500,000

Depreciation 500,000

EBIT $1,000,000

Interest 500,000

EBT $500,000

Taxes 200,000

Net income $ 300,000

The company’s president is disappointed with the forecast and would like to see the company generate higher sales and a forecasted net income of $750,000. Assume that the president wants to maintain the same proportion of operating costs (excluding depreciation). Also, assume that depreciation and the company’s tax rate will remain the same. The president wants to reduce the interest expense by $150,000. What should be the level of sales to satisfy the president? a) $4,200,000 b) $3,816,666.67 c) $3,100,000 d) $4,236,666.67 e) None of the above

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Expert Solution

Option (a) is the answer.

First we calculate the tax rate. It will be used in the forecasted figures.

Current tax rate = Tax / EBT * 100

Current tax rate = 200000 / 500000 * 100 = 0.4 * 100 = 40%

Next we will calculate the proportion of operating cost to gross margin. It will be used in forecasted figures.

Operating cost to gross margin ratio = Operating cost / Gross margin * 100

Operating cost to gross margin ratio = 1500000 / 1500000 * 100 = 100%

Now,Forecasted net income (given) = 750000

EBT = Forecasted net income / (1- tax rate)

EBT = 750000 / (1-40%)

EBT = 750000 / 0.6

EBT = 1250000

New interest expense = 500000 - 150000 = 350000

So, New / forecasted EBIT will be calculated as per below equation:

EBT = EBIT - Interest

1250000 = EBIT - 350000

EBIT = 1250000 + 350000

EBIT = 1600000, which is the new or forecasted EBIT.

Depreciation (given) = 500000

New / forecasted Gross margin will be calculated as per below equation:

EBIT = Gross margin - Depreciation

1600000 = Gross margin - 500000

Gross Margin = 1600000 + 500000 = 2100000

Operating cost = 100% of gross margin (as calculated above, in the beginning)

New Operating cost = 2100000

New / forecasted sales will be calculated as per below equation:

Gross margin = Sales - Operating cost

2100000 = Sales - 2100000

Sales = 2100000 + 2100000

Sales = 4200000

jeff jeffy answered 1 year ago

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