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 racetrack owners let you choose one of the following rental options:

Low Overhead Rent - Commission of 30% of total sales

High Overhead Rent - $1,000 fixed rental cost for the entire weekend

Your food and beverage costs are 20% of total sales. You also have to pay an employee $400 to run the cart over the weekend.

Question 1 Find Breakeven

For each scenario, calculate at what level of sales where you will reach the breakeven point.

Question 2 Calculate Degree of Operating Leverage

You estimate that your sales for the weekend will either be average or great:

Average: $2,800 in sales

Great: 50% higher than average or $4,200

What is your degree of leverage at AVERAGE sales of $2,800 for both the low and high overhead scenario?

Operating Leverage = Sales Total Variable Cost

Sales Total Cost (Fixed and Variable)

Question 3 Calculate Profits and Increase In Profitability

Calculate the profit potential for an average and great weekend for both the low overhead scenario and the high overhead scenario.

How much did profits increase by relative to an increase in sales for both scenarios?

How does this compare with the answers you derived in question 2?

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 Profits	Faster	Slower