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Assignment -8

LEVERAGE
Topics:
Operating Leverage
Break-Even Analysis Degree of Operating Leverage (DOL) DOL and the Break-Even Point DOL and
Business Risk

Leverage:
The use of fixed costs in an attempt to increase (or lever up) profitability.
Operating leverage
The use of fixed operating costs by the firm.

Degree of operating leverage (DOL)


The percentage change in a firms operating profit (EBIT) resulting from a 1 percent change in
output (sales).
Break-even analysis:
A technique for studying the relationship among fixed costs, variable costs, sales volume, and profits.
It is also called cost/volume/profit (C/V/P) analysis.

Q 1: Fine Leather Enterprises sells its single product for $129.00 per unit. The firms fixed
operating costs are
$473,000 annually and its variable operating costs are $86.00 per unit.
Find the firms operating breakeven point in units.
(11000 units)

Q2: Stallings Specialty Paint Company has fixed operating costs of $3 million a year. Variable
operating costs are $1.75 per half pint of paint produced, and the average selling price is $2 per
half pint.
a. What is the annual operating break-even point in half pints (QBE)? In dollars of sales (SBE)?
b. If variable operating costs decline to $1.68 per half pint, what would happen to the operating
break-even point (QBE)?
c. If fixed costs increase to $3.75 million per year, what would be the effect on the operating
break-even point (QBE)?
d. Compute the degree of operating leverage (DOL) at the current sales level of 16 million half
pints.
e. If sales are expected to increase by 15 percent from the current sales position of
16 million half pints, what would be the resulting percentage change in operating profit (EBIT)
from its current position?
(a,12 millions 24millions, b.9,375 millions, c.15 millions, d. 4, e.60%)
Q3: Gahlon Gearing, Ltd., has a DOL of 2 at its current production and sales level of 10,000
units. The resulting operating income figure is $1,000.
a. If sales are expected to increase by 20 percent from the current 10,000-unit sales position,
what would be the resulting operating profit figure?
($1,400)
b. At the companys new sales position of 12,000 units, what is the firms new DOL figure?
(1.7)
(ANNUAL 2015)

Q4: The Andrea S. Fault Seismometer Company is an all-equity-financed firm. It earns monthly,
after taxes, $24,000 on sales of $880,000. The tax rate of the company is 40 percent.
The companys only product, The Desktop Seismometer, sells for $200, of which
$150 is variable cost. (Annual 2010)
a. What is the companys monthly fixed operating cost?
(180,000)
b. What is the monthly operating break-even point in units? In dollars?
(3600, 720,000)
c. Compute and plot the degree of operating leverage (DOL) versus quantity produced and sold
for the following possible monthly sales levels: 4,000 units; 4,400 units; 4,800 units; 5,200 units;
5,600 units; and 6,000 units.
d. What does the graph that you drew (see Part (c)) and especially the companys DOL at its
current sales figure tell you about the sensitivity of the company are operating profit to changes
in sales?
Q5: What would be the effect of the following on the break-even point of the Andrea S. Fault
Company (Problem 1)?
a. An increase in selling price of $50 per unit (assume that sales volume remains constant)
b. A decrease in fixed operating costs of $20,000 per month
c. A decrease in variable costs of $10 per unit and an increase in fixed costs of $60,000 per
month
Q 6: The Crazy Horse Hotel has a capacity to stable 50 horses. The fee for stabling a horse is
$100 per month. Maintenance, depreciation, and other fixed operating costs total $1,200 per
month. Variable operating costs per horse are $12 per month for hay and bedding and $8 per
month for grain.
a. Determine the monthly operating break-even point (in horses stabled).
b. Compute the monthly operating profit if an average of 40 horses is stabled.

Q7: Levin Corporation has fixed operating costs of $72,000, variable operating costs of $6.75
per unit, and a selling price of $9.75 per unit.
a. Calculate the operating breakeven point in units.
b. Compute the degree of operating leverage (DOL) for the following unit sales levels: 25,000,
30,000, and 40,000. Use the formula given in the chapter.
c. Compute the degree of operating leverage at 24,000 units