Question

The Sterling Tire Company's income statement for 20X1 is as follows:

STERLING TIRE COMPANY Income Statement For the Year Ended December 31, 20X1
Sales (23,000 tires at $66 each)	$1,518,000
Variable costs (23,000 tires at $33)	759,000
Fixed costs	430,000
Earnings before interest and taxes (EBIT)	$ 329,000
Interest expense	51,500
Earnings before taxes (EBT)	$277,500
Income tax expense (30%)	83,250
Earnings after taxes (EAT)	$ 194,250

a. Compute the degree of operating leverage.

b. Compute the degree of financial leverage.

c. Compute the degree of combined leverage.

d. Compute the break-even point in units.

Answer 1

Answer 2

SOLUTION :

a.

Degree of operating leverage (DOL)

= (Sales - Variable costs) / EBIT

= (1518000 - 759000) / 329000

= 759000 / 329000

= 2.30699

= 2.31  (ANSWER)

b.

Degree of financial leverage (DFL)

= EBIT / EBT 

= 329000 / 277500

= 1.1856

= 1.19(ANSWER).

c.

Degree of combined leverage 

= Contribution margin / EBT  

=  (1518000 - 759000) / 277500

= 2.7351

= 2.74 (ANSWER).

d.

Break-even Point  in units = Fixed costs / Unit contribution margin

= 430000 / (66 - 33)

= 13030.30

= 13030 tiress (ANSWER).