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PROBLEM 1 Sam Holdings is planning to open a new wholesaling operation. The target operating profit...

PROBLEM 1

Sam Holdings is planning to open a new wholesaling operation. The target operating profit margin is 25%. The unit contribution margin will be 40% of sales. Average annual sales are forecast to be $4,250,000. The firm's total asset is $8,750,000 with debt-asset ratio of 40%. The firm pays 12% interest on the debt and has 100,000 common stocks. The firm is subjected to corporate tax rate of 28%.

  1. How much is the fixed cost for the operation (assuming 25% target operating profit margin is achieved).

  1. What is the breakeven point in dollars for the firm?

(1 mark)

  1. What is the degree of operating leverage (DOL)?

(1 mark)

  1. What is the degree of combined/total leverage (DCL/DTL)?

  1. What will be its earnings per share if average annual sales drop by 20%?

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Answer #1

Given,

Contribution margin = 40%

That Contribution margin = $4,250,000 * 40% = $ 1,700,000

Operating Profit margin = 25% = 4,250,000*25% = 1,062,500

Fixed cost for the operation be = 1,700,000 - 1,062,500 = $ 637,500

Break even point in dollars for the firm = Fixedcosts/contribution margin ratio = 637500/40% = $ 1,593,750

Degree of operating Leverage = Contribution/operating profit = 1700000/1062500 = 1.6

Degree of combined leverage = Contribution/Earnings Before tax = 1700000/1475694 = 1.152

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