Problem 11-18 Operating Leverage [LO4] Consider a four-year project with the fol

Question

Problem 11-18 Operating Leverage [LO4] Consider a four-year project with the following information: initial fixed asset investment $550,000; straight-line depreciation to zero over the four-year life; zero salvage value, price = $26; variable costs = $18, fixed costs = $100,000; quantity sold = 85,000 units; tax rate = 34 percent. What is the degree of operating leverage at the given level of output? (Do not round intermediate calculations. Round your answer to 4 decimal places, e.g., 32,1616.) Degree of operating leverage What is the degree of operating leverage at the accounting break-even level of output? (Do not round intermediate calculations. Round your answer to 4 decimal places, e.g., 32.1616.) Degree of operating leverage

Explanation / Answer

(a) Using the tax shield approach, the OCF at 85,000 units will be:

OCF = [(P – v)Q – FC](1 –TC) +TC*Dep

OCF = [($26 – 18)(85,000) – $190,000](1 – 0.34) +0 .34($550,000 / 4)

OCF = $370,150

At 85,000 units, the DOL is:DOL = 1 + FC / OCF

DOL = 1 + ($190,000 / $370,150)

DOL = 1.5133

Degree of Operating leverage = 1.5133

(b)The accounting break-even is:QA= (FC + D) / (P – v)

QA= [$190,000 + ($550,000 / 4)] / ($26 – $18)

QA= 40,937.5 = 40,938

And, at the accounting break-even level, the DOL is:

DOL = 1 + [$190,000 / ($550,000 / 4)]

DOL = 2.3818

Degree of Operating leverage = 2.3818

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