Question

OceanGate sells external hard drives for $104 each. Its total fixed costs are $35 million, and its variable costs per unit are $68. The corporate tax rate is 31%. 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 will be the percentage decline in sales if the economy enters a recession? (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.)

b. What will be the percentage decline in profits if the economy enters a recession? (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.)

c. Calculate the operating leverage of this firm? (Round your answer to 2 decimal places.)

Answer 1

	Economy
	Strong	Recession
Drivers sold	4000000	2000000
Sales	416000000	208000000
(-) Variable cost	272000000	136000000
Contribution margin	144000000	72000000
(-) Fixed costs	35000000	35000000
Profit before tax	109000000	37000000
(-) Tax @ 31%	33790000	11470000
Net income	75210000	25530000

a. Precentage decline in sales = ( Units in Recession - Units in strong economy ) / Units in strong economy = ( 2000000 - 4000000 ) / 4000000	-50.00%
b. Percentage decline in profits = ( Net income in Recession - Net income in strong economy ) / Net income in strong economy = ( 25530000 - 75210000 ) / 75210000	-66.06%
c. Operating leverage = Contribution marging / Profit before tax = 144000000 / 109000000	1.32