OceanGate sells external hard drives for $153 each. Its total fixed costs are $29 million, and its variable costs per unit are $92. The corporate tax rate is 36%. If the economy is strong, the firm will sell 4 million drives, but if there is a recession, it will sell only half as many.
a. What will be the percentage decline in sales if the economy enters a recession? (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.)
b. What will be the percentage decline in profits if the economy enters a recession? (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.)
c. Calculate the operating leverage of this firm? (Round your answer to 2 decimal places.)
a.% DECLINE IN SALES = 50%
b.% decline in profits
Profits when economy is strong= [(153-92)*4 million - 29 million](1-36%)
= 137.6 million
Decline in profits = 137.6 million - [(153-92)*2 million-29 million](1-36%)
= $78.08 million
% decline in profits = 78.08 million/137.6 million
= -56.74%
c.Degree of operating leverage = Change in profits/Change in sales
= 56.74/50
= 1.1349
i.e. 1.13
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