Problem for Chapter 20 Use the following data to construct an income statement f

Question

Problem for Chapter 20 Use the following data to construct an income statement for Chery's posters Sales price Variable Cost Fixed costs Sales in Units $20 per unit $10 per unit $5,000 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% 2. 3, increase/decrease in sales? 4. Explain using the concept of leverage.

Explanation / Answer

Ans.1 Sales (1000 * 20) 20000 Less: Variable cost (1000*10) -10000 Contribution 10000 Less: Fixed cost -5000 EBIT 5000 Ans. 2 50% increase in sales: Sales (1500 * 20) 30000 Less: Variable cost (1500*10) -15000 Contribution 15000 Less: Fixed cost -5000 EBIT 10000 50% decrease in sales: Sales (500 * 20) 10000 Less: Variable cost (500*10) -5000 Contribution 5000 Less: Fixed cost 5000 EBIT 0 Ans.3 When the sales increase by 50%, the EBIT will be increase by 100%. When the sales decrease by 50%, the EBIT will be decrease by 100%. Ans.4 Degree of operating leaverage: Percentage change in contribution / percentage change in EBIT increase in contribution: 50% / 100% 0.5 decrease in contribution: 50% / 100% 0.5 In both of the condition the DOL will be same because the change in contribution and change in EBIT are equal in both of the situation (whereas it is increase or decrease).

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