Healthy Foods, Inc., sells 50-pound bags of grapes to the military for $10 a bag. The fixed costs of this operation are $80,000, while the variable costs of the grapes are $.10 per pound.
a. What is the break-even point in bags?
b. Calculate the profit or loss on 12,000 bags and on 25,000 bags.
c. What is the degree of operating leverage at 20,000 bags and at 25,000 bags?
Why does the degree of operating leverage change as the quantity sold
increases?
d. If Healthy Foods has an annual interest expense of $10,000, calculate the degree of financial leverage at both 20,000 and 25,000 bags.
e. What is the degree of combined leverage at both sales levels?
What is your question on this?
To answer these questions, we need to understand a few concepts:
1. Break-even point: This is the point at which total revenue equals total costs, resulting in neither profit nor loss. In this case, we'll calculate the number of bags needed to cover all costs.
2. Profit or loss: This is the difference between total revenue and total costs. We'll calculate the profit or loss for different quantities of bags sold.
3. Degree of operating leverage: This measures the relationship between the quantity of goods sold and the operating profit. It indicates how sensitive the profit is to changes in sales volume.
4. Degree of financial leverage: This measures the relationship between the quantity of goods sold and the earnings before interest and taxes (EBIT). It indicates how sensitive the earnings before interest and taxes are to changes in sales volume.
5. Degree of combined leverage: This combines the degree of operating leverage and the degree of financial leverage to show the overall impact of changes in sales volume on earnings.
Now, let's calculate the answers:
a. To find the break-even point in bags, we need to calculate the total cost and divide it by the selling price per bag. The total cost includes both fixed costs and variable costs.
Total cost = Fixed costs + (Variable costs per bag × Number of bags)
Fixed costs = $80,000
Variable costs per bag = $0.10 × 50 pounds = $5
Selling price per bag = $10
Break-even point = Total cost ÷ Selling price per bag
b. To calculate the profit or loss on a specific number of bags, we need to subtract the total cost from the total revenue.
Total revenue = Selling price per bag × Number of bags
Profit or loss = Total revenue - Total cost
c. The degree of operating leverage can be calculated using the formula:
Degree of operating leverage = Contribution margin ÷ Operating income
where Contribution margin = Total revenue - Variable costs
Operating income = Total revenue - Total costs
To find the degree of operating leverage at different quantities of bags sold, we'll calculate the contribution margin and the operating income using the formulas above.
d. The degree of financial leverage can be calculated using the formula:
Degree of financial leverage = EBIT ÷ (EBIT - Interest expense)
where EBIT = Earnings Before Interest and Taxes
To calculate the degree of financial leverage, we need the EBIT, which can be calculated as follows:
EBIT = Total revenue - Total costs
e. The degree of combined leverage can be calculated by multiplying the degree of operating leverage and the degree of financial leverage.
By following these steps and using the given information, we can find the answers to each question.