Question

Consider a four-year project with the following information: initial fixed asset investment = $560,000; straight-line depreciation to zero over the four-year life; zero salvage value; price = $38; variable costs = $26; fixed costs = $235,000; quantity sold = 82,000 units; tax rate = 25 percent.

  

a.	What is the degree of operating leverage at the given level of output? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)
b.	What is the degree of operating leverage at the accounting break-even level of output? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)

Answer 1

Initial Investment = $560,000
Useful Life = 4 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $560,000 / 4
Annual Depreciation = $140,000

Contribution Margin per unit = Selling Price per unit - Variable Cost per unit
Contribution Margin per unit = $38.00 - $26.00
Contribution Margin per unit = $12.00

Accounting Breakeven Point = (Fixed Costs + Depreciation) / Contribution Margin per unit
Accounting Breakeven Point = ($235,000 + $140,000) / $12.00
Accounting Breakeven Point = 31,250 units

Answer a.

Level of Output = 82,000

Operating Cash Flow = (Contribution Margin per unit * Level of Output - Fixed Costs) * (1 - tax) + tax * Depreciation
Operating Cash Flow = ($12.00 * 82,000 - $235,000) * (1 - 0.25) + 0.25 * $140,000
Operating Cash Flow = $749,000 * 0.75 + 0.25 * $140,000
Operating Cash Flow = $596,750

Degree of Operating Leverage = 1 + Fixed Costs / Operating Cash Flow
Degree of Operating Leverage = 1 + $235,000 / $596,750
Degree of Operating Leverage = 1.3938

Answer b.

Level of Output = 31,250

Operating Cash Flow = (Contribution Margin per unit * Level of Output - Fixed Costs) * (1 - tax) + tax * Depreciation
Operating Cash Flow = ($12.00 * 31,250 - $235,000) * (1 - 0.25) + 0.25 * $140,000
Operating Cash Flow = $140,000 * 0.75 + 0.25 * $140,000
Operating Cash Flow = $140,000

Degree of Operating Leverage = 1 + Fixed Costs / Operating Cash Flow
Degree of Operating Leverage = 1 + $235,000 / $140,000
Degree of Operating Leverage = 2.6786