To be profitable, a firm has recover its costs. These costs include both its fix

Question

To be profitable, a firm has recover its costs. These costs include both its fixed and its vanable costs. One way that a firm evaluates at what stage it would recover the invested costs is to calculate how many units or how much in dollar sales is necessary for the firm to earn a profit. Consider the case of Blue Mouse Manufacturers: Blue Mouse Manufacturers is considering a project that will have fixed costs of $15,000,000. The product will be sold for $37.50 per unit, and will incur a variable cost of $10.75 per unit. Given Blue Mouse's cost structure, it will have to sell 560,748 units to break even on this project (Qse) Blue Mouse Manufacturers's marketing sales director doesnt think that the market for the firm's goods is big enough to sell enough units to make the company's target operating profit of $25,000,000. In fact, she believes that the firm will be able to sell only about 175,000 units. However, she also thinks the demand for Blue Mouse Manufacturers's product is relatively inelastic, so the firm can increase the sale price. Assuming that the firm can sell 175,000 units what price must it set to meet the CFO's EBIT goal of $25,000,000? O $275.22 O $299.15 $239.32 O $251.29 What affects the firm's operating break-even point? Several factors affect a firm's operating break-even point. Based on the scenarios described in the following table, indicate whether these factors would increase, decrease, or leave unchanged a firm's break-even quantity-assuming that only the listed factor changes and all other relevant factors remain constant. Increase Decrease No Change The firm's fixed costs increase. The variable cost per unit decreases. The amount of debt increases, causing the firm's total interest expense to increase. When a large percentage of a firm's costs are fixed, the firm is said to have a degree of operating leverage.

Explanation / Answer

1) Let the sales price be "p".

EBIT = $25,000,000

or, Sales - Variable cost - Fixed Costs = $25,000,000

or, p x 175000 - $10.75 x 175000 - $15,000,000 = $25,000,000

or, p = $239.32

2) The break even point is given as -

Break - even point = Fixed Costs / Contribution per unit

Or, Break - even point = Fixed costs / (Selling price per unit - Variable cost per unit)

i) If the fixed costs increase, the numerator will increase, so the break even point will also increase.

ii) If the variable cost per unit decreases, the denominator will increase thereby decreasing the break-even point.

iii) Interest expense does not have any involvement in the operating break - even point, so the break - even point will have no change.

3) Degree of operating leverage shows the effect of operating leverage on the EBIT of a company. Operating leverage is the proportion of fixed costs used in the total costs of the company. If the fixed costs are high, the firm is said to have a high degree of operating leverage.

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