Question

The Sterling Tire Company’s income statement for 20XX is as follows:    STERLING TIRE COMPANY Income Statement...

The Sterling Tire Company’s income statement for 20XX is as follows:

   STERLING TIRE COMPANY
Income Statement
Year ended December 31, 20XX
  Sales (25,000 tires at $40 each) $ 1,000,000
      Less: Variable costs (25,000 tires at $15) 375,000
  Contribution margin 625,000
      Less: Fixed costs 500,000
  Earnings before interest and taxes (EBIT) 125,000
  Interest expense 75,000
  Earnings before taxes (EBT) 50,000
  Income tax expense (32%) 16,000
  
  Earnings after taxes (EAT) $ 34,000

Given this income statement, compute the following:

a. Degree of operating leverage. (Round the final answer to 2 decimal places.)

DOL             X

b. Degree of financial leverage. (Round the final answer to 2 decimal places.)

DFL             X

c-1. Degree of combined leverage. (Do not round the intermediate calculations. Round the final answer to 2 decimal places.)

DCL             X

c-2. Using your answers to a. and b. calculate the percentage increase in EBIT and EBT from a 20 percent increase in sales volume. (Do not round the intermediate calculations. Round the final answers to 2 decimal places.)

  EBIT %
  EBT %

c-3. Does financial or operating leverage have the greater impact?

  • DFL

  • DOL

d. Break-even point in units. (Round the final answer to the nearest whole number.)

Break-even point             tires

e. Break-even point considering the interest expense as a fixed cost.

Break-even point             tires

Business   Accounting   
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Homework Answers

Answer #1

a) degree of operating leverage

= Contribution margin/EBIT

= $625000/$125000 = 5

b) degree of financial leverage = EBIT/EBT

= $125000/$50000 = 2.5

C1)COMBINED LEVERAGE = contribution margin/EBT

= $625000/$50000 = 12.5

C2) percentage change in EBIT = DEGREE OF operating leverage× percentage change in sales

,= 5×20% = 100%

Percentage change in EBT = DEGREE OF COMBINED LEVERAGE× PERCENTAGE CHANGE IN SALES

= 12.5×20%= 250%

C3 ) DEGREE OF OPERATING LEVERAGE HAS MORE IMPACT than financial leverage

d) break even point in unit's = fixed expenses/contribution margin per unit

contribution margin = selling price - variable expenses per unit

= $40 - $15 = $25

= $500000/$25 = 20000 tires

e) break even point in unit's fixed expenses including interest expense

= $500000+$75000/$25 = 23000 tires

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