United snack company sells 50 pound bags of peanuts to university dormitories fo

Question

United snack company sells 50 pound bags of peanuts to university dormitories for $10 a bag the fixed costs of this operation are 80 000 while the variable cost of peanuts are $.10 per round.

a. What is the break-even point in bags?
b. Calculate the profit or loss on 12,000 bags and on 25,000 bags.
c.What is the degreeof operating leverage at 20,000 bags andat 25,000 bags? Why does the degree of operating leverage change as the quantity sold increases?
d. If the United Snack Company has an annual interest expense of 10,000, calculate the degree of financial leverage at both 20,000 and 25,000 bags.
e. What is the degree of combined leverage at both sales levels?

Explanation / Answer

VC = 50*0.1 = 5 ($), Contribution C = 10 - 5 = 5($) a) BEP = FC/ C = 80000/5 = 16000 bags b) for 12000 bags, loss = short of BEP*C = (16000-12000)*5 = 20000 ($) and for 25000 bags, profit = above BEP*C = (25000-16000)*5 = 45000($) c) leverage = (FC-interest)/TVC = (80000-10000)/(5*20000) = 0.7 = 70% at 20000 level leverage = (FC-interest)/TVC = (80000-10000)/(5*25000) = 0.56 = 56% at 25000 level leverage falls with increase in sale as TVC increases with sale. d) financial leverage=interest/TVC=10000/(5*20000) = 0.1 = 10% at 20000 level financial leverage=interest/TVC=100000/(5*25000) = 0.08= 8% at 25000 level e) combined leverage = FC/TVC = 80000/(5*20000) = 0.8 = 80% at 20000 level combined leverage = FC/TVC = 80000/(5*25000) = 0.64 = 64% at 25000 level

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