Chapter 5 Discussion Problem Firm A Firm B units Price Variable Cost Fixed Costs
ID: 2821233 • Letter: C
Question
Chapter 5 Discussion Problem Firm A Firm B units Price Variable Cost Fixed Costs Interest Expense Tax Rate 1,000.00 40.00 30.00 3,000.00 200.00 0.25 units Price Variable Cost Fixed Costs Interest Expense Tax Rate 2,000.00 12.00 8.00 1,200.00 100.00 0.25 0,000.00 Sales 2,000 30,000.00 ess Variable Costs8.00 at 3,000.00 7,000.00 Sales 1,000.00 units at 40.00 dollars Less Variable Costs (30.00 at 1,000.00 units) Fixed costs Earnings before interest and taxes (EBIT) Interest expense Earnings before taxes (EBT) Income tax expense Earnings after taxes (EAT) 00 units at 2.00 dolla 24,000.00 2,00 16,000.00 1,200.00 Earnings before interest and taxes (EBIT) 6,800.00 100.00 6,700.00 1,675.00 5,025.00 Fixed costs 200.00 6,800.00 1,700.00 5,100.00 Interest expense Earnings before taxes (EBT) Income tax expense Earnings after taxes (EAT) Using the Income Statements (above), compute the degree of operating leverage, degree of financial leverage, degree of combined leverage, and the break-even point in units for each firm Part 1 a. Degree of operating leverage b. Degree of financial leverage c. Degree of combined leverage d. Break-even point in units times times times times times times units units Part 2 Whic firm is riskier? Why?Explanation / Answer
Answer to Part 1.
Point a.
Degree of Operating Leverage = Contribution Margin / Earnings before Interest and Taxes
Firm A:
Contribution Margin = Sales – Variable Cost
Contribution Margin = $40,000 - $30,000
Contribution Margin = $10,000
Degree of Operating Leverage = 10,000 / 7,000
Degree of Operating Leverage = 1.43 times
Firm B:
Contribution Margin = Sales – Variable Cost
Contribution Margin = $24,000 - $16,000
Contribution Margin = $8,000
Degree of Operating Leverage = 8,000 / 6,800
Degree of Operating Leverage = 1.18 times
Point b.
Degree of Financial Leverage = Earnings before Interest and Taxes / Earnings before Taxes
Firm A:
Degree of Financial Leverage = 7,000 / 6,800
Degree of Financial Leverage = 1.03 times
Firm B:
Degree of Financial Leverage = 6,800 / 6,700
Degree of Financial Leverage = 1.01 times
Point c.
Degree of Combined Leverage = Degree of Operating Leverage * Degree of Financial Leverage
Firm A:
Degree of Combined Leverage = 1.43 * 1.03
Degree of Combined Leverage = 1.47 times
Firm B:
Degree of Combined Leverage = 1.18 * 1.01
Degree of Combined Leverage = 1.19 times
Point d.
Break Even Point (in Units) = Fixed Cost / Contribution Margin per Unit
Contribution Margin per Unit = Selling Price per Unit – Variable Cost per Unit
Firm A:
Contribution Margin per Unit = $40.00 - $30.00
Contribution Margin per Unit = $10.00
Break Even Point (in Units) = 3,000 / 10.00
Break Even Point (in Units) = 300 Units
Firm B:
Contribution Margin per Unit = $12.00 - $8.00
Contribution Margin per Unit = $4.00
Break Even Point (in Units) = 1,200 / 4.00
Break Even Point (in Units) = 300 Units
Answer to Part 2.
Firm A is higher riskier, as it has higher Leverage Ratio.
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