Question

OceanGate sells external hard drives for $200 each. Its total fixed costs are $30 million, and its variable costs per unit are $140. The corporate ta rate is 30%. If the economy is strong, the firm will sell 2 million drives, but if there is a recession, it will sell only half as many.a. What is the firms' degree of operating leverage?b. If the economy enters a recession, what will be the firm's after tax cost of profit?

Answer 1

a. 1.33

b. $337,000,000

Step-by-step explanation:

Degree of operating leverage = Contribution ÷ Earnings Before Interest and Tax

= 2,000,000 × ($200 - $140) ÷ ($120,000,000 - $30,000,000)

= 1.33

Recession : After tax Cost of Profit

Sales (2,000,000 × $200) $400,000,000

Less Variable Costs (2,000,000 × $140) ($280,000,000)

Contribution $120,000,000

Fixed Cost ($30,000,000)

Profit Before Tax $90,000,000

Taxation ($27,000,000)

Profit After tax $63,000,000

After tax Cost of Profit = Sales - Profit After tax \

= $400,000,000 - $63,000,000

= $337,000,000