Operating leverage. Colour Rugs is holding a 2-week carpet sale at Jerry’s Club, a local warehouse store. Colour Rugs plans to sell carpets for $600 each. Colour Rugs will purchase the carpets from a local distributor for $420 each with the privilege of returning any unsold units for a full refund. Jerry’s Club has offered Colour Rugs two payment alternatives for the use ofspace.

Option 1: A fixed payment of $6,000.

Option 2: 10% of the total revenues earned during the sale period. Assume Colour Rugs will incur no other costs.

Required 1. Calculate the breakeven point in units for

(a) option 1 and

(b) option 2.

2. At what level of sales revenue will Colour Rugs earn the same operating income under either option?

3.

a. For what range of unit sales will Colour Rugs prefer option 1 ?

b. For what range of unit sales will Colour Rugs prefer option 2?
4. Calculate the degree of operating leverage at sales of 100 units for the two alternative rental options.
5. Briefly explain and interpret your answer in requirement 4.