Question

New England Fastener Ltd makes a patented marine bulkhead latch that wholesales for $6.00. Each latch has variable operating costs of $3.50. Fixed operating costs are $50 000 per year. The firm pays $13 000 interest and preference dividends of $7000 per year. At this point, the firm is selling 30 000 latches a year and is taxed at 30%.

1. Calculate New England Fastener’s operating break-even point.
2. Based on the firm’s current sales of 40 000 units per year and its interest and preference dividend costs, calculate its EBIT and net profit available for ordinary shareholders.
   1. Calculate the firm’s DOL.
   2. Calculate the firm’s DFL.
   3. Calculate the firm’s DTL.
3. New England Fastener has entered into a contract to produce and sell an additional 15, 000 latches in the coming year. Use the DOL, DFL and DTL to predict and calculate the changes in EBIT and net profit available for ordinary shareholders. Check your work by a simple calculation of New England Fastener’s EBIT and net profit available for ordinary shareholders using the basic information given.

(please show working out)

Answer 1

a...break-even point. = Fixed Cost/ Contribution * Sales = 50000*6/3.5 = $ 85,714.29

b.... Based on the firm’s current sales of 40 000 units per year and its interest and preference dividend costs, calculate its EBIT and net profit available for ordinary shareholders

EBIT = 330,000 and net profit available for ordinary shareholders = 214,900

c.... DOL = Percetage change in EBIT / Percentage change in Sales = 0.4043/0.333 = 1.21 times

d. DFL =  Percetage change in Earnings available for equity / Percentage change in EBIT = 0.4481/0.4043 = 1.109 times

e. DTL = DOL * DFL = 1.21*1.109 = 1.344 times