Question

To be profitable, a firm has recover its costs. These costs include both fixed and variable costs. One way that a firm evaluates at what stage it would recover its invested costs is to calculate how many units or how much in dollar sales is necessary for the firm to earn a profit.

Consider the case of Defense Dynamics:

Defense Dynamics Inc. is considering a project that will result in fixed costs of $12,000,000 and per-unit variable costs of $10.75. The company's output will be sold for $41.50 per unit. Defense Dynamics will have to sell_(507,317, 604,878, 312,195, 390244)_units (QBEQBE) to break even on the project. (Hint: Round your answer to the nearest whole unit.)

Defense Dynamics’s marketing sales director doesn’t think that the market for the firm’s goods is big enough to sell enough units to make the company’s target operating profit of $15,000,000. In fact, she believes that the firm will be able to sell only about 175,000 units. However, she also thinks the demand for Defense Dynamics’s product is relatively inelastic, so the firm can increase the sale price. Assuming that the firm can sell 175,000 units, what price must it set to meet the CFO’s EBIT goal of $15,000,000?

$239.31 per unit

$189.80 per unit

$165.04 per unit

$288.82 per unit

What affects the firm’s operating break-even point?

Several factors affect a firm’s operating break-even point. Based on the scenarios described in the following table, indicate whether these factors would increase a firm’s break-even quantity, decrease the break-even quantity, or lead to no change.

	Increase	Decrease	No Change
The amount of debt increases, causing interest expense to increase.
Only the fixed cost increases.
Only the sales price increases.

When a large percentage of a firm’s costs are fixed, the firm is said to have a__(low or high)_degree of operating leverage.

Answer 1

1. BEP in Units

BEP = Fixed Cost / Contribution Margin = $12000000 / ($41.50 - $10.75) = 390244 Units

2. Computation of Selling price required to earn EBIT of $15000000

Selling price = (Total Contribution / Total Units) + Variable Cost

Selling price = (EBIT + Fixed Cost / Total Units) + Variable Cost

Selling price = (($12000000 + $15000000 )/ 175000) + 10.75

Selling price = $154.29 + 10.75 = 165.04

3. Effect over BEP

4. When a large percentage of a firm’s costs are fixed, the firm is said to have a High degree of operating leverage.