Subject: Corporate Finance

Hi,

In measuring Operating risk, I'm trying to understand where the numbers ( circled in red) are coming from? Please explain, write it plain as to how the writer arrived at these numbers.

Wonder Cars LLC manufactures components for the automotive industry. Being an industrial company with significant needs in terms of productive capacity, its cost structure characterized by high fixed costs. More specifically, in the current conditions, Wonder Cars: Sells only one product with a unit price of $850; Bears variable costs of $250 for every piece produced; and . Bears total fixed costs of $2,000,000 per year. Assuming that the company is now producing and selling 10,000 pieces per year, let us calculate the degree of operating leverage when the company increases its production by 5%. With 10,000 units sold, Wonder Cars generates revenue of $8,500,000 and bears total costs of $4,500,000. It translates into an operating income of $4,000,000. . With 10,500 units sold, Wonder Cars generates revenue of $8,925,000 ajd bears total costs of $4,625,000. It translates an operating income of $4,300,000. We can now calculate the degree of operating leverage: . The numerator of the equation is equal to 7.5%, which is the percentage increase in operating income; . The denominator of the equation is equal to 5%, which is the percentage increase in the units sold. Therefore, the DOL is 1.5