Question

Consider a four-year project with the following information: initial fixed asset investment = $635,000; straight-line depreciation to zero over the four-year life; zero salvage value; price = $53; variable costs = $44; fixed costs = $310,000; quantity sold = 127,000 units; tax rate = 25 percent. a. What is the degree of operating leverage at the given level of output? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.) b. What is the degree of operating leverage at the accounting break-even level of output? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)

Answer 1

Initial Fixed Asset Investment = $635,000
Useful Life = 4 years

Annual Depreciation = Initial Fixed Asset Investment / Useful Life
Annual Depreciation = $635,000 / 4
Annual Depreciation = $158,750

Contribution Margin per unit = Selling Price per unit - Variable Costs per unit
Contribution Margin per unit = $53.00 - $44.00
Contribution Margin per unit = $9.00

Answer a.

Operating Cash Flow = [Contribution per unit * Sales Volume - Fixed Costs] * (1 - tax) + tax * Depreciation
Operating Cash Flow = [$9.00 * 127,000 - $310,000] * (1 - 0.25) + 0.25 * $158,750
Operating Cash Flow = $833,000 * 0.75 + 0.25 * $158,750
Operating Cash Flow = $664,437.50

Degree of Operating Leverage = 1 + Fixed Costs / Operating Cash Flow
Degree of Operating Leverage = 1 + $310,000 / $664,437.50
Degree of Operating Leverage = 1 + 0.4666
Degree of Operating Leverage = 1.4666

Answer b.

Accounting Breakeven Point = (Fixed Costs + Depreciation) / Contribution Margin per unit
Accounting Breakeven Point = ($310,000 + $158,750) / $9.00
Accounting Breakeven Point = $468,750 / $9.00
Accounting Breakeven Point = 52,083 units

Operating Cash Flow = [Contribution per unit * Sales Volume - Fixed Costs] * (1 - tax) + tax * Depreciation
Operating Cash Flow = [$9.00 * 52,083 - $310,000] * (1 - 0.25) + 0.25 * $158,750
Operating Cash Flow = $158,747 * 0.75 + 0.25 * $158,750
Operating Cash Flow = $158,747.75

Degree of Operating Leverage = 1 + Fixed Costs / Operating Cash Flow
Degree of Operating Leverage = 1 + $310,000 / $158,747.75
Degree of Operating Leverage = 1 + 1.9528
Degree of Operating Leverage = 2.9528