A project has fixed costs of $2,400 per year, depreciation charges of $300 a year, annual...

A project has fixed costs of $2,400 per year, depreciation charges of $300 a year, annual revenue of $21,600, and variable costs equal to two-thirds of revenues.

a. If sales increase by 19%, what will be the percentage increase in pretax profits?

b. What is the degree of operating leverage of this project?

Expert Solution

Revenue		$ 21,600
Less: Variable cost	(2/3 of revenue)	$ (14,400)
Contribution		$ 7,200
Less: Depreciation		$ (300)
Less: Fixed Cost		$ (2,400)
		$ 4,500

a. Sales increase by 19%; percentage increase in pretax profits?

Revenue	(21600*1.19)	$ 25,704
Less: Variable cost	(2/3 of revenue)	$ 17,136
Contribution		$ 8,568
Less Depreciation		$ (300)
Less Fixed Cost		$ (2,400)
		$ 5,868

Increase in pretax profit = (5868 - 4500) / 4500 = 1368 / 4500 = 0.304

Hence, Increase in pretax profit = 30.40%

b. Degree of operating leverage of project

		Original structure	Sales increase 19%
Revenue		$ 21,600	$ 25,704
Less: Variable cost	(2/3 of revenue)	$ 14,400	$ 17,136
Contribution		$ 7,200	$ 8,568
Less Fixed Cost		$ (2,400)	$ (2,400)
Net Operating income (NOI)		$ 4,800	$ 6,168

Operating leverage	Contribution / NOI	=7200 / 4800	=8568 / 6168
		1.50	1.39

jeff jeffy answered 2 years ago

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