5. Eaton Tool Company has fixed costs of $255,000, sells its units for $66, and has variable costs of $36 per unit.
a. Compute the break-even point.
b. Ms. Eaton comes up with a new plan to cut fixed costs to $200,000. However, more labor will now be required, which will increase variable costs per unit to $39. The sales price will remain at $66. 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)?
The Sterling Tire Company’s income statement for 2013 is as follows:
Degree of leverage
(LO5-2 & 5-5)
STERLING TIRE COMPANY
For the Year Ended December 31, 2013
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.
International Data Systems information on revenue and costs is only relevant up to a sales volume of 105,000 units. After 105,000 units, the market becomes saturated and the price per unit falls from $14.00 to $8.80. Also, there are cost overruns at a production volume of over 105,000 units, and variable cost per unit goes up from $7.00 to $8.00. Fixed costs remain the same at $55,000.
Nonlinear breakeven analysis
a. Compute operating income at 105,000 units.
b. Compute operating income at 205,000 units.
Short-term versus longer-term borrowing
Sauer Food Company has decided to buy a new computer system with an expected life of three years. The cost is $150,000. The company can borrow $150,000 for three years at 10 percent annual interest or for one year at 8 percent annual interest.