Question

Consider a four-year project with the following information: initial fixed asset investment = $625,000; straight-line depreciation to zero over the four-year life; zero salvage value; price = $51; variable costs = $39; fixed costs = $300,000; quantity sold = 121,000 units; tax rate = 23 percent. |

a. |
What is the degree of operating leverage at the given level of
output? |

b. |
What is the degree of operating leverage at the accounting
break-even level of output? (Do not round intermediate
calculations and round your answer to 4 decimal places, e.g.,
32.1616.) |

Answer #1

a) Statement showing OFC

Particulars | Amount |

Selling price per unit | 51 |

Less : Variable cost per unit | 39 |

Contribution per unit | 12 |

No of units sold | 121000 |

Total contribution | 1452000 |

Less : Fixed cost | 300000 |

Less : Depreciation | 156250 |

EBIT | 995750 |

Less : Tax @ 23% | 229023 |

NOPAT | 766728 |

Add: Depreciation | 156250 |

Operating cash flow | 922978 |

Degree of operating leverage = 1 + Fixed cost/OFC

=1 + 300000/922978

=1+0.3250

=1.3250

b) Accounting break even point = Fixed cost + depreciation / contribution per unit

=300000+156250 / (51-39)

=456250/12

=38020.83

i.e 38021 units

Statement showing OFC

Particulars | Amount |

Selling price per unit | 51 |

Less : Variable cost per unit | 39 |

Contribution per unit | 12 |

No of units sold | 38021 |

Total contribution | 456252 |

Less : Fixed cost | 300000 |

Less : Depreciation | 156250 |

EBIT | 0 |

Less : Tax @ 23% | 0 |

NOPAT | 0 |

Add: Depreciation | 156250 |

Operating cash flow | 156250 |

Degree of operating leverage = 1 + Fixed cost/OFC

=1 + 300000/156250

=1+1.9200

=2.9200

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