Wolsey Industries Inc expects to maintain the same inventories at the end of 201

Question

Wolsey Industries Inc expects to maintain the same inventories at the end of 2014 as at the beginning of the year. The total of all production cost for the year is therefore assumed to be equal to the cost of goods sold. With this in mind, the various department heads were asked to submit estimates of the cost for their departments during 2014. A summary report for these estimates is as follows:

It is expected that $21,875 units will be sold at a price of $160 a unit. Maximum sales within the relevant range are 27,000 units.

DETERMINE THE OPERATING LEVERAGE

Estimated Fixed Cost Estimated Variable Cost (per unit sold) Production cost: Direct Materials …………………………… $              -   $             46 Direct Labor ………………………………. $              -   $             40 Factory Overhead …………………………. $ 200,000.00 $             20 Selling expenses: Sales salaries and commisions …………….. $ 110,000.00 $               8 Advertising ………………………………… $   40,000.00 $               8 Travel ……………………………………… $   12,000.00 $              -   Miscellaneus selling expense ………………. $    7,600.00 $               1 Administrative expenses: Office and officer's salaries ………………… $ 132,000.00 $              -   Supplies ……………………………………. $   10,000.00 $               4 Miscellaneus administrative expense ……… $   13,400.00 $               1 Total ……………………………………… $ 525,000.00 $            128

Explanation / Answer

At current expected sales Level of 21,875 units

Contribution = 21,875 * (160-128)

= $ 700,000

EBIT = $ 700,000 - $ 525,000

= $ 175,000

If quantity Sold is at its Maximum i.e. 27,000 units

= 864,000/339,000

= 2.54

Hence, Degree of Operating Leverage lies between 2.54 to 4

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