Separate the expenses between fixed and variable costs per unit. Using this information and the sales price per unit of $8, compute the break-even point. 5-3. Solution: Therapeutic Systems Fixed CostsVariable Costs (per unit) Rent$120,000 Factory labor$1. 50 Executive under contract$112,000 Raw materials. 70 $232,000$2. 20 4. Break-even analysis (LO2) Draw two break-even graphs—one for a conservative firm using labor-intensive production and another for a capital-intensive firm. Assuming these companies compete within the same industry and have identical sales, explain the impact of changes in sales volume on both firms’ profits. -4. Solution: Labor-Intensive and capital-intensive break-even graphs The company having the high fixed costs will have lower variable costs than its competitor since it has substituted capital for labor. With a lower variable cost, the high fixed cost company will have a larger contribution margin. Therefore, when sales rise, its profits will increase faster than the low fixed cost firm and when the sales decline, the reverse will be true. 5. Break-even analysis (LO2) Eaton Tool Company has fixed costs of $200,000, sells its units for $56, and has variable costs of $31 per unit. a.
Compute the break-even point. b. Ms. Eaton comes up with a new plan to cut fixed costs to $150,000. However, more labor will now be required, which will increase variable costs per unit to $34. The sales price will remain at $56. What is the new break-even point? c. Under the new plan, what is likely to happen to profitability at very high volume levels (compared to the old plan)? 5-5. Solution: Eaton Tool Company a. b. The breakeven level decreases. c. With less operating leverage and a smaller contribution margin, profitability is likely to be less than it would have been at very high volume levels. . Break-even analysis (LO2) Jay Linoleum Company has fixed costs of $70,000. Its product currently sells for $4 per unit and has variable costs per unit of $2. 60. Mr. Thomas, the head of manufacturing, proposes to buy new equipment that will cost $300,000 and drive up fixed costs to $105,000. Although the price will remain at $4 per unit, the increased automation will reduce variable costs per unit to $2. 25. As a result of Thomas’s suggestion, will the break-even point go up or down? Compute the necessary numbers. 5-6. Solution: Jay Linoleum Company The break-even point will go up. 7.
Cash break-even analysis (LO2) Calloway Cab Company determines its break-even strictly on the basis of cash expenditures related to fixed costs. Its total fixed costs are $400,000, but 20 percent of this value is represented by depreciation. Its contribution margin (price minus variable cost) for each unit is $3. 60. How many units does the firm need to sell to reach the cash break-even point? 5-7. Solution: Calloway Cab Company Cash related fixed costs = Total Fixed Costs – Depreciation = $400,000 – 20% ($400,000) = $400,000 – $80,000 = $320,000 9. Cash break-even analysis (LO2) Boise Timber co. omputes its break-even point strictly on the basis of cash expenditures related to fixed costs. Its total fixed costs are $6,000,000, but 25 percent of this value is represented by depreciation. Its contribution margin (price minus variable cost) for each unit is $4. How many units does the firm need to sell to reach the cash break-even point? 5-9. Solution: Boise Timber Co. Cash related fixed costs = Total Fixed Costs – Depreciation = $6,000,000 – 25% ($6,000,000) = $6,000,000 – $1,500,000 = $4,500,000 10. Degree of leverage (LO2 & 5) The Sterling Tire Company’s income statement for 2010 is as follows: STERLING TIRE COMPANY Income Statement
For the Year Ended December 31, 2010 Sales (20,000 tires at $60 each)$1,200,000 Less: Variable costs (20,000 tires at $30)600,000 Fixed costs 400,000 Earnings before interest and taxes (EBIT)200,000 Interest expense 50,000 Earnings before taxes (EBT)150,000 Income tax expense (30%) 45,000 Earnings after taxes (EAT)$ 105,000 Given this income statement, compute the following: a. Degree of operating leverage. b. Degree of financial leverage. c. Degree of combined leverage. d. Break-even point in units. 5-10. Solution: Sterling Tire Company Q = 20,000, P = $60, VC = $30, FC = $400,000, I = $50,000 a. b. c. d.