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Chapter 2: 13BP_c (page 148)

United Snack Company sells 50-pound bags of peanuts to university dormitories for \(20 a bag. The fixed costs of this operation are \)176,250, while the variable costs of peanuts are $0.15 per pound.

c. What is the degree of operating leverage at 19,000 bags and at 24,000 bags?

Why does the degree of operating leverage change as the quantity sold

increases?

Short Answer

Expert verified

The operating leverage at 19,000 bags is 3.88 and at 24,000 bags is 2.42.

The operating leverage changes because the contribution and EBIT earned by the company changes when the change in sales volume.

Step by step solution

01

Income statement at the sales volume of 19,000 bags and at 24,000 bags

Particulars

19,000 bags

24,000 bags

Sales

$380,000 (19,000 x $20)

$480,000 (24,000 x $20)

Less: variable cost

142,500 (19,000 x $7.50)

180,000 (24,000 x $7.5)

Contribution

$237,500

$300,000

Less: Fixed cost

176,250

176,250

EBIT

61,250

123,750

02

Operating leverage at 19,000 bags

Operatingleverage=ContributionEBIT=$237,500$61,250=3.88

03

Operating leverage at 24,000 bags

Operatingleverage=ContributionEBIT=$300,000$123,750=2.42

The degree of operating leverage decreases because the EBIT of the company increases with a high rate in comparison to the contribution, which is increased with a lower rate. The EBIT increases due to an increase in sales.

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Most popular questions from this chapter

Using the income statement for Times Mirror and Glass Co., compute the following ratios:

The total assets for this company equal \(80,000. Set up the equation for the Du Pont system of ratio analysis, and compute c, d, and e.

d. Total assets turnover ratio.

Times mirror and glass company

Sales

\)126,000

Less: Cost of goods sold

93,000

Gross profit

\(33,000

Less: selling and administrative expenses

11,000

Lease Expenses

4,000

Operating profit*

\)18,000

Less: Interest expenses

3,000

Earning before taxes

\(15,000

Less: Taxes (30%)

4,500

Earning after taxes

\)10,500

*equal income before interest and taxes

What is the difference between accumulated depreciation and depreciation expense? How are they related?

Lemon Auto Wholesalers had sales of \(1,000,000 last year, and cost of goods sold represented 78 percent of sales. Selling and administrative expenses were 12 percent of sales. Depreciation expense was \)11,000 and interest expense for the year was \(8,000. The firm’s tax rate is 30 percent.

a. Compute earnings after taxes.

b. Assume the firm hires Ms. Carr, an efficiency expert, as a consultant. She suggests that by increasing selling and administrative expenses to 14 percent of sales, sales can be increased to \)1,050,900. The extra sales effort will also reduce cost of goods sold to 74 percent of sales. (There will be a larger markup in prices as a result of more aggressive selling.) Depreciation expense will remain at \(11,000. However, more automobiles will have to be carried in inventory to satisfy customers, and interest expense will go up to \)15,800. The firm’s tax rate will remain at 30 percent. Compute revised earnings after taxes based on Ms. Carr’s suggestions for Lemon Auto Wholesalers. Will her ideas increase or decrease profitability?

Perez Corporation has the following financial data for the years 20X1 and 20X2:

20X1

20X2

Sales

\(8,000,000

\)10,000,000

Cost of goods sold

6,000,000

9,000,000

Inventory

800,000

1,000,000

b. Compute inventory turnover based on an alternative calculation that is used by many financial analysts, Cost of goods sold/Inventory, for each year.

For December 31, 20X1, the balance sheet of Baxter Corporation was as follows:

Current assets

Liabilities

Cash

\(15,000

Accounts payable

\)17,000

Accounts receivable

20,000

Notes payable

25,000

Inventory

30,000

Bonds payable

55,000

Prepaid expenses

12,500

Fixed assets

Stockholder’s equity

Plant and equipment (gross)

Less: accumulated depreciation

\(255,000

51,000

Preferred stock

\)25,000

Net plant and equipment

\(204,000

Common stock

60,000

Paid in capital

30,000

Retained earnings

69,500

Total assets

\)281,500

Total liabilities and stockholder’s equity

\(281,500

Sales for 20X2 were \)245,000, and the cost of goods sold was 60 percent of sales. Selling and administrative expense was \(24,500. Depreciation expense was 8 percent of plant and equipment (gross) at the beginning of the year. Interest expense for the notes payable was 10 percent, while the interest rate on the bonds payable was 12 percent. This interest expense is based on December 31, 20X1 balances. The tax rate averaged 20 percent.

\)2,500 in preferred stock dividends were paid, and \(5,500 in dividends were paid to common stockholders. There were 10,000 shares of common stock outstanding.

During 20X2, the cash balance and prepaid expenses balances were

unchanged. Accounts receivable and inventory increased by 10 percent. A new machine was purchased on December 31, 20X2, at a cost of \)40,000. Accounts payable increased by 20 percent. Notes payable increased by \(6,500 and bonds payable decreased by \)12,500, both at the end of the year. The preferred stock, common stock, and paid-in capital in excess of par accounts did not change.

b. Prepare a statement of retained earnings for 20X2.
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