The Harmon Company manufactures skates. The company's income statement for 2004 folle Harmon Company Income statement For the Year ended december 31. 2004 Sales(30,000 skates @$25 each $750,000 Less: Variable costs(30,000 skates at $7)..... 210.000 Fixed costs 270000 Earnings before interest and taxes (EBIt) 270.000 Interest expens 170.000 Earnings before taxes(EBT 100.000 Income tax expense(35%) 35.000 Earnings after taxes (EAT Given this income statement, compute the following a. Degree of operating leverage b. D of financial ley c. Degree of combined leverage d. Break-even point in units Solution: Harmon Company Q=30,000,P=$25,VC=$7,FC=$270,000,=$170,000 . DOL= Q(P-vC) Q(P-VC)-FC 30000(825-$7) 30000425-$7)-$270000 30000($18 30000618)-$270000 Copyright o by The McGraw-Hill Companies. In
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-169 5-9. The Harmon Company manufactures skates. The company's income statement for 2004 is as follows: Harmon Company Income Statement For the Year Ended December 31, 2004 Sales (30,000 skates @ $25 each)........................... $750,000 Less: Variable costs (30,000 skates at $7)............ 210,000 Fixed costs........................................................... 270,000 Earnings before interest and taxes (EBIT).............. 270,000 Interest expense....................................................... 170,000 Earnings before taxes (EBT)................................... 100,000 Income tax expense (35%)...................................... 35,000 Earnings after taxes (EAT)...................................... $65,000 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. Solution: Harmon Company Q = 30,000, P = $25, VC = $7, FC = $270,000, I = $170,000 ( ) ( ) ( ) ( ) ( ) 30,000 ($18) $270,000 30,000 $18 30,000 $25 $7 $270,000 30 000 $25 $7 Q P VC FC Q P VC a. DOL − = − − − = − − − =
5-9. Continued $540,000 $540.000 =2x $540000-$270000$270.000 EBIT b. DFL $27000 EBII-I$270000-$170000 $270000 =2.7x $100.000 Q(P-vC) Q(P-VC)-FC-I 30,000($25-$7 30000425-$7)$270.000-170.000 30000(18) $540,00054x 3000018)-$4400010000 $270000 d. be= 15.000 units $25-$7 Copyright o2005 by The McGranr-Hill Companies, Inc. S-170
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-170 5-9. Continued 2.7x $100,000 $270,000 $270,000 $170,000 $270,000 EBIT I EBIT b. DFL 2x $270,000 $540,000 $540,000 $270,000 $540,000 = = − = − = = = − = ( ) ( ) ( ) ( ) ( ) ( ) 5.4x $100,000 $540,000 30,000 $18 $440,000 30,000 $18 30,000 $25 $7 $270,000 $170,000 30,000 $25 $7 Q P VC FC I Q P VC c. DCL = = − = − − − − = − − − − = 15,000 units $25 $7 $270,000 d. BE = − =
University Catering sells 50-pound bags of popcorn to university dormitories for $10 a bag. The fixed costs of this operation are $80,000, while the variable costs of the popcorn are $. 10 per pound a. What is the break-even point in bags? b. Calculate the profit or loss on 12,000 bags and 25,000 bags c. What is the degree of operating leverage at 20,000 bags and 25,000 bags? Why does the degree of operating leverage change as the quantity sold increases? d. If University Catering has an annual interest payment of$10,000, calculate the degree of financial leverage at both 20.000 and 25.000 bags What is the degree of combined leverage at both sales levels? Solution: University Catering 80.000 . bE= $80,000 =16,000bags $10-($.10×50 12,000bags25,000bags Sales a 10 per bag $120,000 $250,000 Less:Variables Costs($5) (60,000)(125,000) Fixed Costs (80000 (80.000) Profit or loss ($20,000) 45.000 DOL Q(P-VC) Q(P-VC)-FC doL at 20.000 20000($10-$5) 20,000($10-$5)-$80000 $100000 5.00X $20000 S-171 Copyright o by The McGraw-Hill Companies. In
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-171 5-10. University Catering sells 50-pound bags of popcorn to university dormitories for $10 a bag. The fixed costs of this operation are $80,000, while the variable costs of the popcorn are $.10 per pound. a. What is the break-even point in bags? b. Calculate the profit or loss on 12,000 bags and 25,000 bags. c. What is the degree of operating leverage at 20,000 bags and 25,000 bags? Why does the degree of operating leverage change as the quantity sold increases? d. If University Catering has an annual interest payment of $10,000, calculate the degree of financial leverage at both 20,000 and 25,000 bags. e. What is the degree of combined leverage at both sales levels? Solution: University Catering ( ) 16,000 bags $5 $80,000 $10 $.10 50 $80,000 a. BE = = − = b. 12,000 bags 25,000 bags Sales @ $10 per bag $120,000 $250,000 Less: Variables Costs ($5) (60,000) (125,000) Fixed Costs (80,000) (80,000) Profit or Loss ($ 20,000) $ 45,000 ( ) Q (P VC) FC Q P VC c. DOL − − − = ( ) ( ) 5.00x $20,000 $100,000 20,000 $10- $5 $80,000 20,000 $10 $5 DOL at 20,000 = = − − =
5-10. Continued DOL at 25.000 25,000($10-$5) 25000(610-$5)-$80,000 $125000 2.78X $45,000 Leverage goes down because we are further away from the break-even point, thus the firm is operating on a larger profit base and leverage is EBIT . dFL= EBIT First determine the profit or loss(ebit)at 20,000 bags. As indicated in part b, the profit(EBIt)at 25,000 bags is $45,000 20,000bags Sales@$10 per bag $200000 Less: Variable Costs ($5) 10000 Fixed Costs 80.000 Profit or loss $20.000 $20000 DFL at 20.000 $20,000-$10,000 Copyright o2005 by The McGranr-Hill Companies, Inc
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-172 5-10. Continued ( ) ( ) 2.78x $45,000 $125,000 25,000 $10- $5 $80,000 25,000 $10 $5 DOL at 25,000 = = − − = Leverage goes down because we are further away from the break-even point, thus the firm is operating on a larger profit base and leverage is reduced. EBIT I EBIT d. DFL − = First determine the profit or loss (EBIT) at 20,000 bags. As indicated in part b, the profit (EBIT) at 25,000 bags is $45,000: 20,000 bags Sales @ $10 per bag $200,000 Less: Variable Costs ($5) 100,000 Fixed Costs 80,000 Profit or Loss $ 20,000 2.0x $20,000 $10,000 $20,000 DFL at 20,000 = − =
5-10. Continued $45,000 DFL at 25.000 $45,000-$10.000 1.29x DCL Q(P-VC)-FC-I DCL at 20.000 20000610-$5) 20.000(10-$5)-$89000010.000 $100000 =100x $10,000 DCL at 25.000 250$10-$5 25000(10-$5)-$80.000-10,000 $125000 =3.57X $35000 Leno's Drug Stores and Hall's Pharmaceuticals are competitors in the discount drug chain store business. The separate capital structures for Leno and Hall are presented below Leno Hall Debt(@ 10% $100,000Debt@10 200.000 Common stock, $10 par..200000 Common stock, $10 par._ 100.000 Total $300,000 Total.300,000 Shares 2 0. 000 Common shares 10,000 S-173 Copyright o by The McGraw-Hill Companies. In
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-173 5-10. Continued 1.29x $45,000 $10,000 $45,000 DFL at 25,000 = − = ( ) Q (P VC) FC I Q P VC e. DCL − − − − = ( ) ( ) 10.0x $10,000 $100,000 20,000 $10- $5 $80,000 $10,000 20,000 $10 $5 DCL at 20,000 = = − − − = ( ) ( ) 3.57x $35,000 $125,000 25,000 $10 $5 $80,000 $10,000 25,000 $10 $5 DCL at 25,000 = = − − − − = 5-11. Leno’s Drug Stores and Hall’s Pharmaceuticals are competitors in the discount drug chain store business. The separate capital structures for Leno and Hall are presented below. Leno Hall Debt @ 10%....................... $100,000 Debt @ 10%........................$200,000 Common stock, $10 par...... 200,000 Common stock, $10 par ...... 100,000 Total.................................. $300,000 Total ..................................$300,000 Shares................................. 20,000 Common shares................... 10,000