Healthy Foods, Inc., sells 50- pound bags of grapes to the military for $10 a bag. The fixed costs of this operation are $80,000, while the variable costs of the grapes are $.10 per pound. a. what is the break-even point in bags b. calculate the profit of loss on 12,000 bags and on 25,000 bags. c. what is the degree of operating leverage change as the quantity sold increases d. If healthy foods has an annual interest expense of $10,000, calculate the degree of financial leverage at both 20,000 and 25,000 bags e. what is the degree of combined leverage at both sales levels.
a. what is the break-even point in bags
Break-even point = Fixed cost/unit contribution margin
unit contribution margin = selling price per unit – variable cost per unit
= $10 – (50 x 0.10)
= 10 – 5
= $5
Breakeven point = 80,000/5
= 16,000 bags
b. calculate the profit of loss on 12,000 bags and on 25,000 bags.
Desired sales (in units) = (fixed cost + desired profit)/unit contribution margin
12,000 = (80,000 + desired profit)/5
80,000 + desired profit = 60,000
Desired profit/loss = 60,000 – 80,000
Net loss = 20,000
25,000 = (80,000 + desired profit)/5
125,000 = 80,000 + desired profit
Desired profit = 125,000 – 80,000
= 45,000
c. What is the degree of operating leverage at 20,000 bags and at 25,000 bags
What is the degree of operating leverage change as the quantity sold increases
DOL = Q(SP -VC)/ [Q(SP – VC) – FC]
At 20,000 bags
DOL = 20,000 (10 – 5)/ [20,000(10 – 5) – 80,000
= 5
At 25,000 bags:
DOL = 25,000 (10 -5) /[25,000(10 – 5) – 80,000]
= 2.78
Leverage goes down because we are further away from the break-even point, thus the firm is operating on a larger profit base and leverage is reduced.
d. If healthy foods has an annual interest expense of $10,000, calculate the degree of financial leverage at both 20,000 and 25,000 bags
Degree of financial leverage = EBIT/ (EBIT – I)
At 20,000 bags determine the profit:
20,000 = (80,000 + profit)/ 5
Profit/EBIT = 100,000 – 80,000
= 20,000
DFL = 20,000/ (20,000 – 10,000)
= 2
At 25,000 bags we already have calculated Profit/EBIT which is 45,000
DFL = 45,000/(45,000 – 10,000)
= 1.29
e. what is the degree of combined leverage at both sales levels.
Degree of combined leverage = DOL x DFL
At 20,000 bags:
DCL = 5 x 2
= 10
At 25,000 bags:
DCL = 2.78 x 1.29
= 3.57
