Operating Breakeven and Indifference Point Question

Two companies have different levels of fixed and variable operating costs.

Firm LOL has low operating leverage and firm HOL has high operating leverage.

Per unit price and variable cost, and total fixed costs, for both companies are shown in the table:

LOLHOL

Price/unit (P)$120$120

Variable cost/unit (V) $80$70

Fixed Costs (FC)$60,000$80,000

a.What is the breakeven point in units sold and dollar sales for LOL? (show your work)

b.What is the breakeven point in units sold and dollar sales for HOL? (show your work)

c.What is the indifference point in units sold and dollar sales (show your work)?

d.Draw and completely label the Sales-EBIT graph!

6.Financial Leverage Indifference Point

XYZ company is considering two different levels of debt and equity financing.

Option LFL uses low financial leverage and option HFL uses high financial leverage.

Cost of debt (Kd) is 8% and the corporate tax rate (t) is 21 percent

Share price, shares outstanding, and debt financing for both options are shown in the table below:

LFLHFL

Equity Value (E)$800,000$400,000

Debt Value (D)$200,000$600,000

Shares outstanding1,000,000500,000

a.What is the indifference point level of EBIT using the EPS formula? What is EPS at this point?

b.What is the indifference point level of EBIT using the ROE formula? What is ROE?

c.Draw and completely label the EBIT-EPS (or ROE) graph!

7.The Harding Company manufactures skates. The company's income statement for the 2014 is as follows:

For the year ended December 31, 2014

Sales (10,000 skates @ $50 each) .............$500,000

Less: Variable costs (10,000 skates at $20...$200,000

Fixed Costs................................. 150,000

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Earnings before interest and taxes (EBIT)..... 150,000

Interest expense..............................60,000

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Earnings before taxes (EBT)...................90,000

Income tax expense (40%)......................36,000

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Earnings after taxes (EAT)....................$ 54,000

Given this income statement, compute the following:

a.Degree of operating leverage

b.Degree of financial leverage

c.Degree of combined leverage

d.Break-even point in units (numbers of skates)