Question

Oscar Inc. has a new product priced at $500 per unit. Variable cost is $250 per unit, and fixed costs are $200,000 per year. Quantity sold is expected to be 20,000 units per year. The new product will require an initial investment of $14 million, depreciation will be straight-line to zero for seven years, and salvage at the end of seven years is expected to be $1 million. Demand for the product is expected to be stable and to continue for seven years. The required rate of return on this new product line is 12%. Ignoring taxes, what is the financial break-even quantity?

Select one:

a. 8,800

b. 10,295

c. 12,674

d. 15,276

e. 20,000

Oscar Inc. has a new product priced at $500 per unit. Variable cost is $250 per unit, and fixed costs are $200,000 per year. Quantity sold is expected to be 20,000 units per year. The new product will require an initial investment of $14 million, depreciation will be straight-line to zero for seven years, and salvage at the end of seven years is expected to be $1 million. Demand for the product is expected to be stable and to continue for seven years. The required rate of return on this new product line is 12%. What is the degree of operating leverage at the expected quantity sold of 20,000 units?

Select one:

a. 1.02

b. 1.04

c. 1.08

d. 1.12

e. 1.14

Answer 1

TO CALCULATE FINANCIAL BREAKEVEN POINT

WE NEED PV OF INVESTMENT = INITIAL INVESTMENT - PV OF SALVAGE VALUE

= 140,00,000 - (1000000 X PVIF@12%, 7 YEARS)

=140,00,000 - (100000 X0.4523) =135,47,700

AT FINANCIAL BREAKEVEN POINT, NPV =0

SO PV OF INVESTMENT = OPERATING CASHFLOW X PVIFA@12%, 7 YEARS

135,47,700 = OPERATING CASHFLOW X 4.5638

OPERATING CASHFLOW = 2968513.08

NOW FINANCIAL BREAKEVEN POINT IN QUANTITY

SO FORMULA = (FIXED COST + OPERATING CASHFLOW )/ (SP-VC) PER UNIT

SO ANSWER = (200000 +2968513.08)/250 =12674 (ANSWER c : 12674)

DEGREE OF OPERATING LEVERAGE = 1 + FC/OCF (OCF = OPERATING CASH FLOW, FC = FIXED COST)

OCF = QUANTITY(SP-VC) + FC = 20000(500-250) = 5000000

DEGREE OF OPERATING LEVERAGE = 1 + (200000/5000000) = 1.04 ANSWER :b :1.04