Profitability at very high volume levels


Question 1: 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?

c. Under the new plan, what is likely to happen to profitability at very high volume levels (compared to the old plan)?

Question 2: The Sosa Company produces baseball gloves. The company's income statement for 2004 is as follows:

SOSA COMPANY
Income Statement
For the Year Ended December 31, 2004

Sales (20,000 gloves at $60 each) . . . . . . . . . . . . . . . . . . .  $1,200,000
Less: Variable costs (20,000 gloves at $20) . . . . . . . . . . . . .      400,000
Fixed costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .      600,000
Earnings before interest and taxes (EBIT) . . . . . . . . . . . . . . . . . 200,000
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  80,000
Earnings before taxes (EBT) . . . . . . . . . . . . . . . . . . . . . . . . . . . 120,000
Income tax expense (30%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36,000
Earnings after taxes (EAT) . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 84,000

Given this income statement, compute the following:

a. Degree of operating leverage.

b. Degree of financial leverage.

c. Degree of combined leverage.

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Finance Basics: Profitability at very high volume levels
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