Question

OceanGate sells external hard drives for $300 each. Its total fixed costs are $30 million, and its variable costs per unit are $240. The corporate tax rate is 30%. If the economy is strong, the firm will sell 6 million drives, but if there is a recession, it will sell only half as many. a. What is the firm's degree of operating leverage (defined as the ratio of the percent change in EBIT to the percent change in sales) in going from a recession to a strong economy? Degree of operating leverage b. If the economy enters a recession, what will be the firm’s after-tax profit? (Enter your answer in millions.) After-tax profit $ million

Answer 1

EBIT if economy is strong = [($300 - $240) * 6 million] - $30 million

= $360 million - $30 million

= $330 million

If Economy is strong then EBIT of company will be $330 million.

EBIT if there is recession = [($300 - $240) * 3 million] - $30 million

= $180 million - $30 million

= $150 million

If There is recession then EBIT of company will be $150 million.

Percentage change in EBIT = (330 - 150) / 150 *100 = 120

Percentage change in Sales = (1800 - 900) / 900 *100 = 100

Degree of operating leverage = percent change in EBIT to the percent change in sales

= 120 /100

=1.2

b) firm’s after-tax profit

= EBIT * (1- Tax rate)

= 150 million * (1- 0.30)

= 105 million