Big company makes lug nuts and sell them at$6 a pack of 4 with a variable cost o

ID: 2763767 • Letter: B

Question

Big company makes lug nuts and sell them at$6 a pack of 4 with a variable cost of $3.50 per pack. Their fixed operating costs are $50,000 annually. he pays $13,000 in interest each year along with $7,000 in perferred dividend, his current selling price is $30,000 packs annually. His tax rate is 40%.

a) What is the operating breakeven point?

b) based on his current annual level of sales and the interest and the devidends he has to pay, calculate the EBIT and earnings available for common stockholders.

c) calculate their DOL, DFL and DTL (Degree of Total Leverage)

Explanation / Answer

Solution:

Contribution Margin Per Unit = Selling Price Per Unit – Variable Cost per unit = $6 - $3.50 = $2.50

Contribution Margin (%) = Contribution Per Unit / Selling Price per unit = $2.50 / $6 =

Operating Fixed Cost = $50,000

Operating Break Even Point in packs = Operating Fixed Cost / Contribution Margin Per Unit = $50,000 / $2.50 = 20,000 Packs

Operating Break Even Point in dollars = Break Even Point in packs x Selling Price per unit = 20,000 x $6 = $120,000

Calculation of EBIT and Earnings available for common stockholders

Sales (30,000 x $6)

$180,000

Less: Variable Cost (30,000 x $3.5)

($105,000)

Contribution Margin

$75,000

Less: Fixed Cost

($50,000)

Operating Profit before interest & taxes (EBIT)

$25,000

Less: Interest

($13,000)

Profit before taxes (EBT)

$12,000

Less: Tax @ 40%

($4,800)

Profit after tax (EAT)

$7,200

Less: Preferred Dividend

($7,000)

Earnings available for common stockholders

$200

EBIT = $25,000

Earnings available for common stockholders = $200

DOL = Contribution / EBIT = $75,000 / $25,000 = 3 times

DFL = EBIT / EBT = $25,000 / $12,000 = 2.083 times

DTL = DOL X DFL = 3 x 2.083 = 6.25 times