12. The Harmon Company manufactures skates. The company’s income statement
for 2008 is as follows;
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.
12. The Harmon Company manufactures skates. The company’s income statement
for 2008 is as follows;
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.
answer
To compute the following values based on the income statement:
a. Degree of operating leverage:
The degree of operating leverage measures the sensitivity of a company's operating income (EBIT) to changes in sales. It is computed using the following formula:
Degree of Operating Leverage = Contribution Margin / Operating Income
To find the contribution margin, we subtract variable costs from sales:
Contribution Margin = Sales - Variable Costs
= $1,200,000 - $600,000
= $600,000
Degree of Operating Leverage = $600,000 / $200,000
= 3
b. Degree of financial leverage:
The degree of financial leverage measures the sensitivity of a company's earnings per share (EPS) to changes in its operating income (EBIT). It is computed using the following formula:
Degree of Financial Leverage = EBIT / EBT
Degree of Financial Leverage = $200,000 / $150,000
= 1.33
c. Degree of combined leverage:
The degree of combined leverage measures the sensitivity of a company's earnings per share (EPS) to changes in sales. It is computed by multiplying the degree of operating leverage and the degree of financial leverage:
Degree of Combined Leverage = Degree of Operating Leverage * Degree of Financial Leverage
= 3 * 1.33
= 3.99
d. Break-even point in units:
The break-even point in units represents the level of sales at which a company's total cost equals its total revenue, resulting in zero profit. To compute the break-even point, we first need to find the contribution margin per unit:
Contribution Margin per Unit = Sales Price per Unit - Variable Cost per Unit
Contribution Margin per Unit = ($1,200,000 / 20,000) - ($600,000 / 20,000)
= $60 - $30
= $30
Next, we calculate the break-even point in units:
Break-even Point (in Units) = Fixed Costs / Contribution Margin per Unit
Break-even Point (in Units) = $400,000 / $30
= 13,333.33 units
So, the break-even point in units is approximately 13,333.33 units.