Question

OceanGate sells external hard drives for $350 each. Its total fixed costs are $30 million, and its variable costs per unit are $290. The corporate tax rate is 30%. If the economy is strong, the firm will sell 4 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.

Answer 1

Selling price per hard drive = $350
Variable cost per hard drive = $290
Fixed costs = $30 million

Answer a.

% Change in EBIT = ($210.00 - $90.00) / $90.00
% Change in EBIT = 1.3333

% Change in sales = ($1,400.00 - $700.00) / $700.00
% Change in sales = 1.0000

Degree of operating leverage = % Change in EBIT / % Change in sales
Degree of operating leverage = 1.3333 / 1.0000
Degree of operating leverage = 1.3333

Answer b.

After-tax profit during recession is $63.00 million