Construction BETC overview and applications

Business Finance

Healthy Foods Inc. sells 50 pounds bags of grapes to the military for $10 a bag. The fixed costs of this operation are $80,000, while the variable costs of the grapes are $.10 per pound.

What is the break-even point in bags?

Break-Even Point = Fixed Cost / (Unit Price - Variable Unit Cost)

Fixed Cost= $80,000

Variable Unit Cost= variable cost per pound x pounds in a unit= $.1x50= $

Break-Even Point=80,000 / (10-5)= 80000/5= 16,000

So healthy Foods Inc. must sell 16,000 units of 50 lb bags of grapes to the military to break even.

Calculate the profit or loss on 12,000 bags and on 25,000 bags.

Above the breakeven point, every additional unit sold increases profit by the amount of the unit contribution margin (the amount each unit contributes to covering fixed costs and increasing profits).

Unit Contribution Margin = Sales Price - Variable Costs

Sales Price= $

Variable Costs= $

Unit contribution margin= 10-5= 5

Profit= number of units sold above break even point x unit contribution margin

Profit when 25,000 units are sold= $45,000

Number of Units sold above break-even point: 25,000-16,000= 9,000

9,000 x 5 = $45,000 profit

Loss= number of units sold below break-even point x unit contribution margin

Loss when 12,000 units are sold = $4,000

Number of units sold below break-even point: 16,000-12,000= 4,000

4,000 x 5 = $20,000 loss

C. What is the degree of operating leverage at 20,000 bags and at 25,000 bags?

DOL= Total Contribution / Operating Income=

Total Contribution = Unit Contribution x Sales

Operating Income= Total Contribution- fixed costs

DOL at 20,000 bags= 5

Total Contribution = unit contribution x sales= $5 x $20,000= $100,000

Operating Income= Total Contribution - Fixed Costs= $100,000-$80,000= $20,000

DOL at 20,000 bags= $100,000/$20,000= 5

DOL at 25,000 bags= 2.7778

Total Contribution = unit contribution x sales= $5 x $25,000= $125,000

Operating income= Total Contribution -- Fixed Costs= $125,000= $80,000 = $45,000

DOL at 25,000 bags = $125,000/$45,000=2.7778

Why does the degree of operating leverage change as the quantity sold increases?

The Degree of operating leverage is a unit of measure on the return on fixed assets. The degree represents the ratio between a change in profits and a change in revenue. A higher ratio is a sign of increased variability in revenue and therefore higher risk. Higher ratios usually occur when the amount of units sold are closer to the break-even point and usually decreases as the amount of units sold increases. This phenomenon is because fixed costs are decreasing in relative importance and variable costs are increasing in relative importance as the number of units sold increases. Thus, the degree of operating leverage is ?declining.

D. If Healthy Foods has an annual interest expense of $10,000, calculate the degree of financial leverage at both 20,000 and 25,000 bags.