Question

The Poseidon Swim Company produces swim trunks. The average selling price for one of their swim trunks is $61.42. The variable cost per unit is $19.91, Poseidon Swim has average fixed costs per year of $6390. Assume that current level of sales is 494 units. What will be the resulting percentage change in EBIT if they expect units sold to change by 6.2 percent?

Answer 1

Firstly, we will calculate Degree of Operating Leverage using

DOL = Contribution / EBIT

Contribution = (Selling Price per unit - Variable Cost per unit) x No. of Units

= ($ 61.42 - $ 19.91) x 494 units

= $ 41.51 x 494 units

= $ 20,505.94

Total Contribution = $ 20,505.94

EBIT = Contribution - Fixed Costs

= $ 20,505.94 - $ 6,390

= $ 14,115.94

Degree of Operating Leverage = Contribution / EBIT

= $ 20,505.94 / $ 14,115.94

DOL = 1.4527

Now, we will use the formula

DOL = % change in EBIT/ % change in sales

to find out change in EBIT when sales change by 6.2%

= 1.4527 = % change in EBIT / 6.2

% change in EBIT = 1.4527 x 6.2

% change in EBIT = 9.0067% or 9% (approx)

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