Question

Your business plan for your proposed start-up firm envisions first-year revenues of $300,000, fixed costs of $100,000, and variable costs equal to one-third of revenue.

a. What are expected profits based on these expectations?

b. What is the degree of operating leverage based on the estimate of fixed costs and expected profits? (Round your answer to 2 decimal places.)

c. If sales are 10% below expectation, what will be the percentage decrease in profits?

e. Based on the DOL, what is the largest percentage shortfall in sales relative to original expectations that the firm can sustain before profits turn negative? (Round your answer to 1 decimal place.)

f. What are break-even sales at this point?

Answer 1

a.
Revenues	300000
(-) Variable cost [ 1/3*300000 ]	100000
Contribution margin	200000
(-) Fixed costs	100000
Expected profit	100000

b.
Degree of operating leverage (DOL) = Contribution margin / profit = 200000 / 100000	2.00
c.
% decrease in profits = DOL * % decrease in sales = 2.00 * 10%	20%
e.
If profits falls by 100% then they can sustain before turning into negative.
So, the short fall in sales = % decrease in profits / DOL = 100%/2.00	50%
f.
Break-even sales = Fixed costs * Sales / Contribution margin = 100000 * 300000 / 200000	150000