Problem 12-33 OceanGate sells external hard drives for $220 each. Its total fixe
ID: 2762493 • Letter: P
Question
Problem 12-33
OceanGate sells external hard drives for $220 each. Its total fixed costs are $50 million, and its variable costs per unit are $180. The corporate tax rate is 30%. If the economy is strong, the firm will sell 5 million drives, but if there is a recession, it will sell only half as many.
What is the firms' degree of operating leverage (defined as the ratio of the percent change in EBIT to the percent change in sales)?
If the economy enters a recession, what will be the firm’s after-tax profit? (Enter your answer in millions.)
OceanGate sells external hard drives for $220 each. Its total fixed costs are $50 million, and its variable costs per unit are $180. The corporate tax rate is 30%. If the economy is strong, the firm will sell 5 million drives, but if there is a recession, it will sell only half as many.
Explanation / Answer
(a) Ans. (Amount in $ Million)
Situation Storng Recession
Sale price 220 220
Less: Varriable Cost 180 180
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Contribution 40 40
No of Units sold 5 million 2.5 million
Total Contribution 200 100
Less: Fixed Cost 50 50
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EBIT $ 150 $ 50
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Change in % of EBIT=100/150*100=67%
Change in % of Sales= 2.5/5*100=50%
Firms' degree of operating leverage = Change in % of EBIT /Change in % Sales
67%/50%=1.34 Ans.
Ans .(b). EBIT in Recession = $50 Million (Figure taken from above calculation)
Less: Tax @ 30% = $15 Million
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Profit After Tax = $ 35 Million
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