Use the following data to construct an income statement for Cheryl’s posters: Sa

Question

Use the following data to construct an income statement for Cheryl’s posters:

Sales price                              $20 per unit

Variable Cost                          $10 per unit

Fixed costs                              $5,000

Sales in Units                          1,000

Required:

Calculate the Earnings before Interest and Taxes (EBIT) for Cheryl’s Posters using the data provided above.

Prepare two pro forma income statements assuming:

a 50% increase in sales (1,500)

a 50% decrease in sales (500)

What is the impact on earnings before interest and taxes (EBIT) of the 50% increase/decrease in sales?

Explain using the concept of leverage.

Explanation / Answer

1) EBIT = Units sold (Selling price -cosT ) -Fixed cost

                = 1000 ( 20 -10 ) - 5000

               = 1000 * 10 -    5000

                =10000 -5000

                = $ 5000

2 )a

4) As using original data ,Degree of operating leverage = contribution /EBIT

                                                       = 10000 / 5000

                                                         = 2 OR 200%

Therefore it means with increase/decrease in x% in sales , EBIT will increase /decrease to 200%

50% increase 50% decrease sales 30000    [1500*20] 10000     [500*20] less:Variable cost - 15000   [1500*10] - 5000    [500*10] contribution 15000 5000 less:fixed cost -5000 -5000 EBIT 10000 0 EBIT increase by $ 5000   or [10000/ 5000 = 200% ] Decrease by $ 5000

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