.Answer the Tollowing questions: (5 points) a. Compute the profit leverage effec
ID: 2815755 • Letter: #
Question
.Answer the Tollowing questions: (5 points) a. Compute the profit leverage effect "for an organization with revenue of $100 million, purchases of $60 million, and profit of $8 million before tax, a 10 percent reduction in purchase spend would result in: i. How much increase/decrease in profit, please mention the dollar value as well as percentage? i. Assuming the same percentage hold, how much should the value of revenue/sale increase if the profit increase of $5 million were to be possible just via sales? Which of the two would you prefer, decrease of supply cost or increase of sales, explain. ili.Explanation / Answer
Profit Leverage Effect:
Parameter
Value
Percentage of Sales
Revenue
100
100%
Purchase
60
60%
Gross Profit
= (100 – 60) =40
40%
Operating Expenses
= (40 – 8) =32
32%
Profit before tax
8
8%
10% reduction in purchase,
Parameter
Value
Percentage of Sales
Revenue
100
100%
Purchase
= 60 – 6 = 54
54%
Gross Profit
= (100 – 54) = 46
46%
Operating Expenses
32
32%
Profit before tax
= 46 – 32 =14
14%
Profit increased = $ (14-8) million = $ 6 million
Percentage increase = [{(14-6)/6} x 100]% =133.333%
Parameter
Value
Percentage of Sales
Revenue
105
100%
Purchase
= 105 x 0.54 = 56.7
54%
Gross Profit
= (105 - 56.7) = 48.3
46%
Operating Expenses
= 48.3 – 13 = 35.3
32%
Profit before tax
= 8+5 = 13
13%
iii.
Among decrease of supply cost and increase of sales,
decrease of supply cost or COGS is preferable as it is more easier to increase profit.
To increase profit by increasing sales, the sales should go a much higher value than increasing profit by decreasing cost.
Parameter
Value
Percentage of Sales
Revenue
100
100%
Purchase
60
60%
Gross Profit
= (100 – 60) =40
40%
Operating Expenses
= (40 – 8) =32
32%
Profit before tax
8
8%
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