17. As the financial manager for a manufacturing firm, you have constructed the

Question

17. As the financial manager for a manufacturing firm, you have constructed the following partial pro forma income statement for the next fiscal year.

Sales $15,700,000
Variable costs 7,600,000
Revenue before fixed costs 8,100,000
Fixed costs 4,500,000
EBIT 3,600,000
Interest expenses 1,400,000
Earnings before taxes 2,200,000
Taxes (40%) 880,000
Net income $1,320,000

a. What is the degree of operating leverage at this level
of output? 2.25
b. What is the degree of financial leverage? 1.64
c. What is the degree of combined leverage? 3.69
d. What is the break-even point in sales dollars for the
firm?
e. If the average unit cost is $11.25, what is the breakeven
point in units?

Explanation / Answer

a)Degree of Operating leverage = (Sales - Variable Cost)/EBIT = (15,700,000 - 7,600,000)/3,600,000 = 2.25

b) Degree of Financial Leverage = EBIT/(EBIT - Interest) = 3,600,000/(3,600,000-1,400,000) = 1.64

c) Degree of combined leverage = Degree of Operating Levergae * Degree of Financial Leverage = 2.25 * 1.64 = 3.69

d) Contribution Margin Ratio =( Revenues - Variable cost)/ variable costs)/ Revenues =
(15,700,000 - 7,600,000)/15,700,000 = 0.515923
Break even point in sales dollars = Fixed Cost / Contribution margin ratio = 4,500,000/0.515923 = 8,722,231.81

e)No of Units = (Fixed Cost + Variable Cost)/Avarge unit cost = (4,500,000+ 7,600,000)/11.25 = 1,075,555.55
Sales Price/unit = 15,700,000/1,075,555.55 = 14.597
Variable Cost/Unit = 7,600,000 /1,075,555.55 = 7.0661
Break even units = Fixed Cost/( Sales/Unit - variable Cost/Unit) = 4,500,000/(14.597 -7.0661) = 597,538.14 units

Best of Luck. God Bless

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