Question

Consider a four-year project with the following information:

initial fixed asset investment = $470,000; straight-line depreciation to zero over the four-year life; zero salvage value; price = $30; variable costs = $20; fixed costs = $160,000; quantity sold = 77,000 units; tax rate = 30 percent.
1. What is the degree of operating leverage at the given level of output?
2. What is the degree of operating leverage at the accounting break-even level of output?

Answer 1

Answer and Explanation:

1. The computation of the Degree of operating leverage is

= Quantity sold × (Price - Variable cost) ÷ (Quantity sold × (Price - Variable cost) - Fixed cost)

where,

Fixed cost = $160,000 + $470,000 ÷ 4

= $277,500

Now the degree of operating leverage is

= 77000 × ($30 - $20) ÷ ($77,000 × ($30 - $20) - $277,500)

= 1.56

2. The Accounting Break-even level of output is

The break even point is

= Fixed cost ÷ (Price - Variable cost)

= $277500 ÷ ($30 - $20)

= $27,750

As the degree of operating leverage could not be calculated as the denominator comes to zero