Camping USA Inc. has only been operating for 2 years in the outskirts of Albuquerque, New Mexico, and is a new manufacturer of a top-of-the-line camping tent. You are starting an internship as assistant to the chief financial officer of the company, and the owner and CEO, Tom Charles, has decided that this is the right time to know more about the business and financial risks his company must deal with. For this, the CFO has asked you to prepare an analysis to support him in his next meeting with Tom Charles a week from today. To make the required calculations, you have put together the following data regarding the cost structure of the company: Output level 120,000 units Operating assets 6,000,000.00 Operating asset turnover 12 times Return on operating assets 48% Degree of operating leverage 10 times Interest expense $720,000 Tax rate 42% The CFO has instructed you to first determine the break-even point in units of output for the company. He requires that you prepare supporting documents, which demonstrate how you arrived at your conclusion and can facilitate his review of your work. Accordingly, you are required to have the information needed to prepare an analytical income statement for the company to be presented to the CFO. In a format that is acceptable for a meeting discussion with the CEO, you also need to prepare answers to the following questions: a. What is the firm’s break-even point in sales dollars? b. If sales should increase by 40 percent, by what percentage would EBT (earnings before taxes) and net income increase? c. Prepare another income statement, this time to verify the calculations from part b.
Sales
[STEP 2]
(Variable Costs)
[STEP 5]
Revenue before Fixed Costs
[STEP 4]
(Fixed Costs)
[STEP 6]
EBIT
[STEP 3]
(Interest Expense)
Earnings before Taxes
(Taxes @ 42%)
Net Income
$1,252,800
To calculate the break-even point in units of output, we need to determine the level of output at which the company's revenue equals its total costs (both fixed and variable costs).
1. Start by calculating the contribution margin per unit. The contribution margin is the revenue per unit minus the variable cost per unit. In this case, we do not have the specific revenue and variable cost values, so we need to use other information given.
Given:
Operating assets = $6,000,000
Operating asset turnover = 12 times
Return on operating assets = 48%
Output level = 120,000 units
Degree of operating leverage = 10 times
Using the formula for operating asset turnover: Operating asset turnover = Revenue / Operating assets
Rearrange the formula to solve for revenue: Revenue = Operating asset turnover * Operating assets
Revenue = 12 * $6,000,000 = $72,000,000
Using the formula for return on operating assets: Return on operating assets = EBIT / Operating assets
Rearrange the formula to solve for EBIT: EBIT = Return on operating assets * Operating assets
EBIT = 0.48 * $6,000,000 = $2,880,000
From the above information, we can calculate the contribution margin per unit:
Contribution margin per unit = EBIT / Output level
Contribution margin per unit = $2,880,000 / 120,000 units = $24 per unit
2. Next, determine the fixed costs. The fixed costs are given as the interest expense of $720,000.
3. To calculate the break-even point in units of output, use the following formula:
Break-even point (in units) = Fixed costs / Contribution margin per unit
Break-even point (in units) = $720,000 / $24 per unit = 30,000 units
So, the break-even point in units of output for the company is 30,000 units.
a. To determine the firm's break-even point in sales dollars, multiply the break-even point in units by the selling price per unit. However, the selling price per unit is not provided in the given information. Therefore, we cannot determine the break-even point in sales dollars.
b. To calculate the increase in EBT (earnings before taxes) and net income if sales should increase by 40 percent, we need to calculate the new sales and the corresponding EBT and net income.
New sales = Current sales * (1 + Sales increase percentage)
New sales = $72,000,000 * (1 + 40%) = $100,800,000
New EBT = EBIT * (1 + Contribution margin ratio) - Interest expense
New EBT = $2,880,000 * (1 + (Contribution margin per unit / Selling price per unit)) - $720,000
However, we do not have the values for the Contribution margin per unit and Selling price per unit, so we cannot calculate the new EBT and net income.
c. Without the necessary values, we cannot prepare another income statement to verify the calculations from part b.