OceanGate sells external hard drives for $250 each. Its total fixed costs are $30 million, and its variable costs per unit are $200. The corporate tax rate is 30%. If the economy is strong, the firm will sell 2 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?
b. What will be the percentage decline in profits if the economy enters a recession?
c. Comparing your answers to (a) and (b), how would you measure the operating leverage of this firm?
n1=2mn (Strong economy) n2=1mn(recession),
% change in sales=(250*2)-(250*1)/(250*2)
=250/500=50% decline in sales.
(Ebit)=(sales-vc)-fc
(500-400)-30=Ebit1=70mn
Ebit2=(250-200)-30=20
%change in ebit=70-20/70=0.7143 =71.43% decline in profits.
=Hence operating leverage =%change in sales/%change in ebit
=50/70=0.7143.
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