Question

You estimate that your cattle farm will generate $0.10 million of profits on sales of $2 million under normal economic conditions and that the degree of operating leverage is 5. (Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations. Enter your answers in millions.)

a. What will profits be if sales turn out to be $1.6 million?

Profit will____to______million.

b. What if they are $2.4 million?

Profit will____to ______million.

Answer 1

Ans.	Operating leverage = Contribution / Profit
	5   =   Contribution / $100000
	Contribution margin = 5 * $100000
	Contribution margin = $500000
	Contribution margin ratio = Contribution / Sales * 100
	$500000 / $200000 * 100
	25%
	Fixed cost = Contribution margin - Profit
	$500000 - $100000
	$400,000
a	Profit = (Sales * Contribution margin ratio) - Fixed cost
		($1600000 * 25%) - $400000
		$400000 - $400000
		$0 million
	Profit will decrease to $0 million.
b	Profit = (Sales * Contribution margin ratio) - Fixed cost
		($2400000 * 25%) - $400000
		$600000 - $400000
		$200,000
	Profit will increase to 0.20 million (or $200000).