# Chapter_5_-_Moodle_Ready - Chapter 5 Problems 5-A Shawn...

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Chapter 5 Problems 5-A. Shawn Penn & Pencil Sets, Inc., has fixed costs of \$80,000. Its product currently sells for \$5 per unit and has variable costs of \$2.50 per unit. Mr. Bic, the head of manufacturing, proposes to buy new equipment that will cost \$400,000 and drive up fixed costs to \$120,000. Although the price will remain at \$5 per unit, the increased automation will reduce costs per unit to \$2.00. As a result of Bic’s suggestion, will the break-even point go up or down? Compute the necessary numbers. 5-A. Solution: . \$80,000 \$80,000 BE (before) 32,000 units \$5.00 \$2.50 \$2.50 = = = - \$120,000 \$120,000 BE (after) 40,000 units \$5.00 \$2.00 \$3.00 = = = - The break-even point will go up.

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5-B. The Sterling Tire Company’s income statement for 2008 is as follows: STERLING TIRE COMPANY Income Statement For the Year Ended December 31, 2008 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. 5-B. Solution: Sterling Tire Company Q = 20,000, P = \$60, VC = \$30, FC = \$400,000, I = \$50,000 a. Q(P VC) DOL Q(P VC) FC 20,000(\$60 \$30) 20,000(\$60 \$30) \$400,000 20,000(\$30) 20,000(\$30) \$40,000 \$600,000 \$600,000 3.00x \$600,000 \$400,000 \$200,000 - = - - - = - - = - = = = -
b. EBIT \$200,000 DFL EBIT I \$200,000 \$50,000 \$200,000 1.33x \$150,000 = = - - = = c. Q (P VC) DCL Q(P VC) FC I 20,000(\$60 \$30) 20,000(\$60 \$30) \$400,000 \$50,000 \$600,000 \$600,000 4x \$600,000 \$400,000 \$50,000 \$150,000 - = - - - - = - - - = = = - - d. \$400,000 \$400,000 BE 13,333 units \$60 \$30 \$30 = = = - 5-C. Healthy Foods, Inc. Sells 50-pound bags of grapes to the military for \$10 a bag. The fixed costs of this operation are \$80,000, while the variable costs of the grapes are \$.10 per pound. a . What is the break-even point in bags? b . Calculate the profit or loss on 12,000 bags and on 25,000 bags. c . What is the degree of operating leverage at 20,000 bags and at 25,000 bags? Why does the degree of operating leverage change as the quantity sold increases? d . If Healthy Foods has an annual interest expense of \$10,000, calculate the degree of financial leverage at both 20,000 and 25,000 bags. e

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Chapter_5_-_Moodle_Ready - Chapter 5 Problems 5-A Shawn...

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