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.