Question

(Operating leverage​) The C. M. Quarles Distributing Company manufactures an assortment of cold air intake systems for​ high-performance engines. The average selling price for the various units is ​$500. The associated variable cost is ​$300 per unit. Fixed costs for the firm average $ 180, 000 annually.

a. What is the​ break-even point in units for the​ company?

b. What is the dollar sales volume the firm must achieve to reach the​ break-even point?

c. What is the degree of operating leverage for a production and sales level of 5, 000 units for the​ firm? (Calculate to three decimal​ places.)

d. What will be the projected effect on earnings before interest and taxes if the​ firm's sales level should increase by 30 percent from the volume noted in part c​?

Answer 1

a.Break even point in units = Fixed costs/(Selling price per unit – variable costs per unit)
= 180,000/(500-300)

= 900 units

b.Contribution Margin ratio = (Sales – variable costs)/sales

= (500-300)/500

= 40%

Dollar sales volume required = Fixed costs/CM Ratio

= 180,000/40%

= $450,000

c.Degree of Operating leverage = (Sales – variable costs)/(Sales – variable costs – fixed costs)

= (200*5000)/(200*5000-180,000)

= 1.2195

i.e. 1.220 times

d.EBIT will increase by Increase in sales*DOL

= 30%*1.220

= 36.6%

I.e. $1,120,120