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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