Question

Russell Preston delivers parts for several local auto parts stores. He charges clients $1.30 per mile driven. Russell has determined that if he drives 3,500 miles in a month, his average operating cost is $0.85 per mile. If he drives 4,500 miles in a month, his average operating cost is $0.75 per mile. Use this information and the high-low method to determine that his monthly cost equation is: total cost = $1,220.00 + $0.29 per mile.

A. Determine how many miles Russell needs to drive to break even?
B. Assume Russell drove 2,500 miles last month. Without making any additional calculations, determine whether he earned a profit or a loss last month.
C. Determine how many miles Russell must drive to earn $2,135.00 in profit.
D. Prepare a contribution margin income statement assuming Russell drove 2,500 miles last month.
E. Use the above information to calculate Russell’s degree of operating leverage.

Answer 1

A. Determine how many miles Russell needs to drive to break even?

break even formula = total fixed costs / contribution margin

• total fixed costs = $1,220
• contribution margin = $1.30 - $0.29 = $1.01

break even formula = $1,220 / $1.01 = 1,207.9 ≈ 1,208 miles

B. Assume Russell drove 2,500 miles last month. Without making any additional calculations, determine whether he earned a profit or a loss last month.

if he drove 2,500 he made a profit because it is more than the break even point.

C. Determine how many miles Russell must drive to earn $2,135.00 in profit.

($1,220 + $2,135) / $1.01 = 3,321.7 ≈ 3,322 miles

D. Prepare a contribution margin income statement assuming Russell drove 2,500 miles last month.

total revenue $3,250

- variable costs ($725)

contribution margin $2,525

- fixed costs ($1,220)

net income $1,305

E. Use the above information to calculate Russell’s degree of operating leverage.

Degree of operating leverage = contribution margin / operating income = $2,525 / $3,250 = 0.7769 or 77.69%