The Problem You own and manage a pretzel and lemonade concession cart. You decide that you want to sell your products at a NASCAR race weekend in Loudon, NH. The track charges $1,000 in rent for the entire weekend. Food and beverage costs run about 20% of sales. You have to pay an employee $400 to run the cart over the weekend. You provide incentives of 5% of sales. Your accountant allows you to take $250 in depreciation expenses for this weekend as well. Lets pretend you use the cart for only one weekend per year (therefore, this one weekend is your annual sales and expenses). The car costs you $1,250 to purchase and you expect to use it for 5 years (with depreciation of $250 per year). Assume a required rate of return of 15%.

Question 1 Find Accounting and Cash Flow Breakeven

? If the average lemonade or pretzel sale is $5/each, how many items will you have to sell to reach accounting breakeven?

? How many units do you need to sell cash flow breakeven? (Assume no taxes).

? How many units do you need to sell to reach financial breakeven?

Question 2 Calculate Degree of Operating Leverage You estimate that your sales for the weekend will either be average or great:

Average: 500 units sold

Great: 750 Units sold Calculate the degree of leverage at AVERAGE and GREAT sales? DOL = 1 + (FC/OCF)

Question 3 Test your answer! From question 2, increase unit sales 10%. Show that your OCF went up by the degree of operating leverage suggested. Example. Say you calculated a DOL of 2.5. An increase in sales of 10% would suggest OCF would increase 25%. Conclusion Companies with a higher fixed overhead (and hence, lower variable costs relative to fixed costs) must reach a higher level of sales prior to becoming profitable. However, they will enjoy a greater increase in profits as sales increase.

	HIgh Operating Leverage	Low Operating Leverage
Breakeven	Higher	Lower
Increase in Profit	Faster	Slower