Question

Sales revenue for Wholesales ehf is ISK 480,000. Its variable cost is 40% of sales and fixed costs are ISK 80,000.

1. What does the Wholesalers ehf need to sell for great value in order for the business to be in balance (ie where income and expenses are equal)?

2. What is the company's degree of operating leverage, etc. current sales?

3. If Wholesale Sales ehf's sales increase by 10%, how will the results change? Calculate both the percentage change and the change in value.

Answer 1

1. What does the Wholesalers ehf need to sell for great value in order for the business to be in balance (ie where income and expenses are equal)?

In order to to sell for great value in order for the business to be in balance (ie where income and expenses are equal), Wholesalers ehf needs to achieve break even point. Break even point is where the revenue and the costs of a business are equal. Break even point = Fixed costs/Contribution Margin ratio (where Contribution Margin ratio = 1 - Variable costs%)

Contribution Margin ratio = 1-0.4=0,6 or 60%

Break even point = 80,000/0.6 = ISK 133,333

Thus, at a sales revenue of ISK 133,333, Wholesalers ehf will be in balance i.e. no profit no loss.

2. What is the company's degree of operating leverage, etc. at current sales?

Degree of operating leverage = Contribution margin/EBIT (earnings before interest and taxes)

= (Sales - variable costs) / (Sales - variable costs - fixed costs)

=(480,000 - 40% of 480,000) / (480,000 - 40% of 480,000 - 80,000)

=288,000 / 208,000

=1.385

3. If Wholesale Sales ehf's sales increase by 10%

(a) Sales = 480,000+48000=ISK 528,000

Variable costs (ISK 192,000) (assuming variable costs amount will be same) now variable costs = 36% and contribution margin ratio = 64% (1-0.36) will increase.

There will be no change in Fixed costs

Break even point = Fixed costs/Contribution Margin ratio

=80,000/0.64

=125,000

Break even point decreased by ISK 8,333 or 6%

(b) Degree of operating leverage = Contribution margin/EBIT (earnings before interest and taxes)

= (528,000-36% of 528000)/ (528,000-36% of 528000-80,000)

= 192,000/112,000

= 1.714

Hence degree of operating leverage increased by 0.33 or 24%