Pan Guo has fixed costs of $120,000 directly attributable to producing a particular product. The product sells for $3 a unit and variable costs are $2.40.
What is the break-even point in units produced?
If the firm sold 250,000 units last year and expects volume to increase by 5%, what percentage increase in profits would Pan Guo see with this increase in volume?
What is the Degree of Operating Leverage (DOL) at 250,000 units? At 262,500 units?
Answer:
QBE = $120,000/($3 – $2.40) = 200,000 units.
At volume of 250,000 units:
Profit = (250,000)($3) – $120,000 – (250,000)($2.40) = $30,000
At volume of 262,500 units:
Profit = (262,500)($3) – $120,000 – (262,5000)($2.40) = $37,500
Therefore, the percentage increase in profit equals ($37,500 – $30,000)/$30,000 = 25%
DOL250,000 = (EBIT + FC) / EBIT = ($30,000 + $120,000)/$30,000 = 5.00.
DOL262,500 = (EBIT + FC) / EBIT = ($37,500 + $120,000)/$37,500 = 4.2.
