Question

Your business plan for your proposed start-up firm envisions first-year revenues of $180,000, fixed costs of $90,000, and variable costs equal to one-third of revenue.

a. What are the expected profits based on these expectations?

Expected Profits $

b. What is the degree of operating leverage based on the estimate of fixed costs and expected profits? (Round your answer to 2 decimal places.)

Degree of operating leverage -

c. If sales are 10% below expectations, what will be the percentage decrease in profits?

Decrease in profits %

e. Based on the DOL, what is the largest percentage shortfall in sales relative to original expectations that the firm can sustain before profits turn negative? (Round your answer to 1 decimal place.)

Short Fall %

f. What are break-even sales at this point?

Break Even Sales $

Answer 1

a.
Calculation of expected profits based on these expectations
Revenue	$180,000
Less: Variable costs	$60,000	180000/3
Contribution margin	$120,000
Less: Fixed costs	$90,000
Operating income	$30,000
b.
Calculation of degree of operating leverage
Degree of operating leverage	1+Fixed costs/Expected profits
Degree of operating leverage	1+(90000/30000)
Degree of operating leverage	4.00
c.
Calculation of % decrease in profits if sales reduce by 10%
Revenue	$162,000	180000*90%
Less: Variable costs	$54,000	162000/3
Contribution margin	$108,000
Less: Fixed costs	$90,000
Operating income	$18,000
% change in profits	(18000-30000)/30000
% change in profits	-40.00%
e.
Operating profit	Sales*(1-(1/3))-Fixed costs
0	Sales*(1-(1/3))-90000
0	2/3Sales-90000
90000*3/2	Sales
Sales	135000
Short fall %	(135000-180000)/180000
Short fall %	-25.0%
Thus, short fall of 25% in sales from that expected would sustain the firm
f.
Break even sales	$135,000
Break even sales is where there is no profit nor loss for business. At $135,000 in sales the profits would be zero.