FIN 301 YOUR NAME: _________________________ LEVERAGE PROBLEM Pro-Forma Income S

Question

FIN 301                                              YOUR NAME:    _________________________

LEVERAGE PROBLEM

Pro-Forma Income Statement

For Projected Sales Level of $ 1,500,000

            SALES                                                $ 1,500,000

            Less: VC                                               (250,000)

            Gross Profit                                         $   1,250,000

            Less: FC                                                  1.050,000

            EBIT (Operating Profit)                     $     200,000

            ASSUME THIS PRO FORMA INCOME STATEMENT REFLECTS THE OPERATING COST STRUCTURE FOR A NEW PROJECT. WHAT IS PROJECTED OPERATING BREAKEVEN POINT FOR THE COMPANY GIVEN THE PROPOSED COST STRUCTURE?

BE              =

CALCULATE THE COMPANY%u2019S DEGREE OF OPERATING LEVERAGE (DOL),

DOL           =

Using the DOL calculation above, what will be the EBIT if Sales come in 10% BELOW the pro-forma projection?

Explanation / Answer

Hi,

Please find the answers as follows:

Part A:

Break Even = Fixed Cost/Contribution Ratio = 1050000/(1250000/1500000*100) = 1260000

Part B:

Operating Leverage = Contribution Margin/Net Operating Income = 1250000/200000 = 6.25

Part C:

% Change in EBIT with a 10% Reduction in Sales = 6.25*(-10) = -62.5%

Value of EBIT would be = 200000 - 200000*62.5% = 75000

Thanks.

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