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# Chapter 5

Problems
1. Gateway Appliance toasters sell for \$20 per unit, and the variable cost to produce
them is \$15. Gateway estimates that the fixed costs are \$80,000.
a. Compute the break-even point in units.
b. Fill in the table below (in dollars) to illustrate the break-even point has been
achieved.

Sales............................... ____________
– Fixed costs................. ____________
– Total variable costs... ____________
Net profit (loss)............ ____________

1. Solution:
Gateway Appliance
Fixed costs
BE 
a. Pr ice-variable cost per unit

\$80,000 \$80,000
   16,000 units
\$20  \$15 \$5

## b. Sales \$320,000 (16,000 units ×

\$20)
–Fixed costs \$ 80,000
–Total variable costs 240,000 (16,000 units ×
\$15)
Net profit (loss) \$ 0
2. Hazardous Toys Company produces boomerangs that sell for \$8 each and have a
variable cost of \$7.50. Fixed costs are \$15,000.
a. Compute the break-even point in units.
b. Find the sales (in units) needed to earn a profit of \$25,000.

2. Solution:
The Hazardous Toys Company
\$15,000
BE   30,000 units
a. \$8.00  \$7.50

## Profit  FC \$25,000  \$15,000

Q 
(P  VC) \$8.00  \$7.50
\$40,000
  80,000 units
b. \$.50
3. Ensco Lighting Company has fixed costs of \$100,000, sells its units for \$28, and has
variable costs of \$15.50 per unit.
a. Compute the break-even point.
b. Ms. Watts comes up with a new plan to cut fixed costs to \$75,000. However,
more labor will now be required, which will increase variable costs per unit
to \$17. The sales price will remain at \$28. What is the new break-even point?
3. Solution:
Ensco Lighting Company

Fixed costs
BE 
Pr ice  variable cost per unit

\$100,000 \$100,000
   8,000 units
a. \$28  \$15.50 \$12.50

Fixed costs
BE 
Pr ice  variable cost per unit
\$75,000 \$75,000
   6,818 units
b. \$28  \$17 \$11

## The breakeven level decreases.

4. Shawn Penn & Pencil Sets, Inc., has fixed costs of \$80,000. Its product currently sells for
\$5 per unit and has variable costs of \$2.50 per unit. Mr. Bic, the head of manufacturing,
proposes to buy new equipment that will cost \$400,000 and drive up fixed costs to
\$120,000. Although the price will remain at \$5 per unit, the increased automation will
reduce costs per unit to \$2.00.
As a result of Bic’s suggestion, will the break-even point go up or down?
Compute the necessary numbers.

4. Solution:
Shawn Penn & Pencil Sets, Inc.
\$80,000 \$80,000
BE (before)    32,000 units
\$5.00  \$2.50 \$2.50

\$120,000 \$120,000
BE (after)    40,000 units
\$5.00  \$2.00 \$3.00

## The break-even point will go up.

5. The Sterling Tire Company’s income statement for 2008 is as follows:

## STERLING TIRE COMPANY

Income Statement
For the Year Ended December 31, 2008
Sales (20,000 tires at \$60 each)................................. \$1,200,000
Less: Variable costs (20,000 tires at \$30)........... 600,000
Fixed costs................................................... 400,000
Earnings before interest and taxes (EBIT)............. 200,000
Interest expense......................................................... 50,000
Earnings before taxes (EBT)..................................... 150,000
Income tax expense (30%)........................................ 45,000
Earnings after taxes (EAT)....................................... \$ 105,000

## Given this income statement, compute the following:

a. Degree of operating leverage.
b. Degree of financial leverage.
c. Degree of combined leverage.
d. Break-even point in units.

5-11. Solution:
Sterling Tire Company

## Q = 20,000, P = \$60, VC = \$30, FC = \$400,000, I = \$50,000

Q(P  VC)
DOL 
Q(P  VC)  FC

20,000(\$60  \$30)

20,000(\$60  \$30)  \$400,000

20,000(\$30)

20,000(\$30)  \$40,000

\$600,000 \$600,000
   3.00x
a. \$600,000  \$400,000 \$200,000

5-11. (Continued)
EBIT \$200,000
DFL  
EBIT  I \$200,000  \$50,000

\$200,000
  1.33x
b.
\$150,000

Q (P  VC)
DCL 
Q(P  VC)  FC  I

20,000(\$60  \$30)

20,000(\$60  \$30)  \$400,000  \$50,000

\$600,000 \$600,000
   4x
c. \$600,000  \$400,000  \$50,000 \$150,000

\$400,000 \$400,000
BE    13,333 units
d. \$60  \$30 \$30