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Q: degree of operating leverage ( Answered,   1 Comment )
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 Subject: degree of operating leverage Category: Miscellaneous Asked by: jatan-ga List Price: \$20.00 Posted: 13 Aug 2005 08:58 PDT Expires: 12 Sep 2005 08:58 PDT Question ID: 555311
 ```harding company manufactures skates. the company's income statement for 2001 is a follow.``` Clarification of Question by jatan-ga on 13 Aug 2005 12:50 PDT ```The Harding Company manufactures skates. the company's income statement for the 2001 is as follows: Harding Company Income Statement For the year ended december 31, 2001 Sales (10,000 skates @ \$50 each) ............\$500,000 Less: Variable costs (10,000 skates at \$20..\$200,000 Fixed Costs ............................... 150,000 ----------------------------------------------------- Earnings before interest and taxes (EBIT).... 150,000 Interest expense............................. 60,000 ----------------------------------------------------- Earnings before taxes (EBT).................. 90,000 Income tax expense (40%)..................... 36,000 ----------------------------------------------------- Earnings after taxes (EAT)...................\$ 54,000 Given this income statement, compute the following: 1. Degree of operating leverage. 2. Degree of fianancial leverage. 3. Degree of combined leverage. 4. Break-even point in units( numbers of skates).``` Clarification of Question by jatan-ga on 13 Aug 2005 14:21 PDT `Can I get an answer to this?`
 ```Hi!! 1. Degree of operating leverage. Degree of operating leverage (DOL): - It measures the EBIT's percentage change as a result of a change of one percent in the level of output. - It helps in measuring the business risk. To compute it just use the following formula: Degree of operating leverage = Sales revenue less total variable cost divided by sales revenue less total cost: DOL = (Sales-Variable Costs) / (Sales-Variable Costs-Fixed Costs) For this problem: DOL = (\$500,000-\$200,000) / (\$500,000-\$200,000-\$150,000) = = \$300,000 / \$150,000 = = 2 ---------------- 2. Degree of financial leverage. The degree of financial leverage (DFL) is defined as the percentage change in earnings per share [EPS] that results from a given percentage change in earnings before interest and taxes (EBIT): DFL = Percentage change in EPS divided by Percentage change in EBIT The above equation can be worked to get the following equivalent one: DFL = EBIT / (EBIT-I), where I is the interest expense. For this problem: DFL = \$150,000 / (\$150,000-\$60,000) = = \$150,000 / \$90,000 = = 5/3 = 1.67 ---------------- 3. Degree of combined leverage. The degree of combined leverage is also known as degree of total leverage (DTL). To compute it use the following formula: DCL = DOL * DFL For this problem: DCL = 2 * 5/3 = 10/3 = 3.333 -------------------- 4. Break-even point in units( numbers of skates). Break-even point in Units = Fixed Costs / Contribution margin per unit where: Contribution margin per unit = (Revenues - Variable Costs) / Units sold = = Price per unit - Variable cost per unit In effect: The break-even level of sales is the sales point at which EBIT = 0 ; or in other words: break-even point in units = level of sales necessary to cover operating costs. At the break-even level of sales: EBIT = Sales - Variable costs - Fixed costs = 0 then: Sales - Variable costs = Fixed costs If we call: q = quantity sold; p = price per unit; v = variable cost per unit, then Revenues = q.p and Variable costs = q.v We will have: Revenues - Variable costs = q.p - q.v = q.(p - v) Then for the break-even point is: q.(p - v) = Fixed costs ==> q = Fixed costs / (p - v) For this problem is: Variable costs per unit = \$20 Contribution margin per unit = Price per unit - Variable cost per unit = = \$50 - \$20 = = \$30 Break-even point in Units = Fixed Costs / Contribution margin per unit = = \$150,000 / \$30 = = 5,000 The break even point in units is 5,000 skates. ------------------------------------------------------ For references see: "Operating and Financial Leverage" (Ms Powerpoint presentation): http://wps.pearsoned.co.uk/wps/media/objects/1670/1710211/0273685988_ch16.ppt "Introduction to Capital Structure": http://cbdd.wsu.edu/kewlcontent/cdoutput/TR505r/page22.htm ------------------------------------------------------- Search strategy: I used my own knowledge to answer this question, to find the references I used the following search terms in Google: "financial leverage" "operating leverage" "combined leverage" I hope that this helps you. Feel free to request for a clarification if you need it. Regards, livioflores-ga```
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