Question

The Andrea S. Fault Seismometer Company is an all-equity-financed firm. It earns
monthly, after taxes, $24,000 on sales of $880,000. The tax rate of the company is 40 per-
cent. The company’s only product, “The Desktop Seismometer,” sells for $200, of which
$150 is variable cost.
a. What is the company’s monthly fixed operating cost?
b. What is the monthly operating break-even point in units? In dollars?
c. Compute and plot the degree of operating leverage (DOL) versus quantity produced
and sold for the following possible monthly sales levels: 4,000 units; 4,400 units;
4,800 units; 5,200 units; 5,600 units; and 6,000 units.
d. What does the graph that you drew (see Part (c)) – and especially the company’s DOL
at its current sales figure – tell you about the sensitivity of the company’s operating
profit to changes in sales?

Answer 1

Part a

	Remarks		In dollars
Price per unit			200
Variable cost			150
Sales			880000
Total units sold	880000/200		4400
Cost	880000-40000		840000
Total Variable cost		150*4400	660000
Fixed cost	840000-660000		180000
PBT	24000/(1-40%)		40000
Tax rate			40%
PAT			24000

Part b

Monthly operating break even point
Total sales= total cost
200*units= (150*units)+fixed cost
200X=150X+180000
X=180000/(200-150)
X (Units)	3600
X (dollars)	3600*200	720000
Monthly operating break even point is 3600 units with a sales value of 720000 dollars

Part c

Operating leverage = Contribution margin / Net operating income
Contribution margin = sales - variable cost
Sales (Units)	Price per unit	Sales (Dollars)	VC per unit	Total VC	CM	Fixed cost	Profit	DOL
4000	200	800000	150	600000	200000	180000	20000	10
4400	200	880000	150	660000	220000	180000	40000	5.5
4800	200	960000	150	720000	240000	180000	60000	4
5200	200	1040000	150	780000	260000	180000	80000	3.25
5600	200	1120000	150	840000	280000	180000	100000	2.8
6000	200	1200000	150	900000	300000	180000	120000	2.5

Part d

DOL decreases with the increase in sales of units