Operating leverage. Color Rugs is holding a two-week carpet sale at Jerry’s Club, a local warehouse store. Color Rugs plans to sell carpets for $500 each. The company will purchase the carpets from a local distributor for $350 each, with the privilege of returning any unsold units for a full refund. Jerry’s Club has offered Color Rugs two payment alternatives for the use of space.

Option 1: A fixed payment of $5,000 for the sale period
Option 2: 10% of total revenues earned during the sale period

Assume Color 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 revenues will Color Rugs earn the same operating income under either option?

a. For what range of unit sales will Color Rugs prefer option 1?
b. For what range of unit sales will Color Rugs prefer option 2?

3. Calculate the degree of operating leverage at sales of 100 units for the two rental options.
4. Briefly explain and interpret your answer to requirement 3.