Question

OceanGate sells external hard drives for $228 each. Its total fixed costs are $20 million, and its variable costs per unit are $148. The corporate tax rate is 38%. If the economy is strong, the firm will sell 2 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

a.
Strong sales revenue	456000000	2000000*228
Recession sales revenue	228000000	1000000*228
% decline in sales revenue	(228000000-456000000)/456000000
% decline in sales revenue	-50.00%
b.
	Strong	Recession
Sales revenue	$456,000,000	$228,000,000
Variable costs	-$296,000,000	-$148,000,000
	2000000*148	1000000*148
Contribution margin	$160,000,000	$80,000,000
Fixed costs	-$20,000,000	-$20,000,000
Income before taxes	$140,000,000	$60,000,000
Taxes @ 38%	-$53,200,000	-$22,800,000
Net profit	$86,800,000	$37,200,000
% decline in net profit	(37200000-86800000)/86800000
% decline in net profit	-57.14%
c.
Degree of operating leverage	% decline in profits/% decline in sales
Degree of operating leverage	-57.14%/-50%
Degree of operating leverage	1.14