Question

The Sterling Tire Company’s income statement for 20X1 is as follows: STERLING TIRE COMPANY Income Statement For the Year Ended December 31, 20X1 Sales (20,000 tires at $60 each) $1,200,000 Less: Variable costs (20,000 tires at $30) 600,000 Fixed costs 400,000 Earnings before interest and taxes (EBIT) $ 200,000 Interest expense 50,000 Earnings before taxes (EBT) $ 150,000 Income tax expense (30%) 45,000 Earnings after taxes (EAT) $ 105,000 Given this income statement, compute the following: Degree of operating leverage. Degree of financial leverage. Degree of combined leverage. Break-even point in units.

Answer 1

Compute the degree of operating leverage using the equation as follows:

Hence, the degree of operating leverage is 3.

Compute the degree of financial leverage using the equation as follows:

Hence, the degree of financial leverage is 1.33.

Compute the degree of combined leverage using the equation as follows:

Hence, the degree of combined leverage is 4.

Compute the break-even point in units using the equation as follows:

Hence, the break-even point is 133,333 units.