Organic Foods Inc. sells 50-pound bags of grapes to the public schools for $10 a bag. The fixed costs of this operation are $80,000, while the variable costs of 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?
d. If Oganic Foods has an annual interest expense of $10,000, calculate the degree of financial leverage at 20,000 bags.
e. What is the degree of combined leverage at both sales levels?
number of bags = b
number of pounds = 50 b
costs = 80,000 + .10 * 50 b
revenue = 10 b
a) revenue = cost
10 b = 80,000 + 5 b
5 b = 80,000
b =16,000 bags to break even
b) profit = revenue - cost
p = 10(12,000) -80,000 - 5(12,000)
p = -20,000
a loss of course because < 16,000
etc
To find the answers to the questions, we need to understand a few concepts and perform calculations.
a. The break-even point is the point at which total revenue equals total cost, resulting in zero profit or loss. To determine the break-even point in bags, we need to calculate the total cost and the selling price per bag.
Total fixed cost = $80,000
Variable cost per pound = $0.10
Weight per bag = 50 pounds
Selling price per bag = $10
Total cost per bag = Variable cost per pound * Weight per bag + Total fixed cost
= $0.10 * 50 + $80,000
Break-even point in bags = Total fixed cost / (Selling price per bag - Total variable cost per bag)
= $80,000 / ($10 - $0.10)
b. To calculate the profit or loss on a specific number of bags, we need to calculate both the total revenue and total cost.
Total revenue = Selling price per bag * Number of bags
Total cost = Total fixed cost + (Variable cost per pound * Weight per bag * Number of bags)
For 12,000 bags:
Profit or loss = Total revenue - Total cost
= ($10 * 12,000) - ($80,000 + ($0.10 * 50 * 12,000))
For 25,000 bags:
Profit or loss = Total revenue - Total cost
= ($10 * 25,000) - ($80,000 + ($0.10 * 50 * 25,000))
c. The degree of operating leverage is a measure of how much operating income (profit) changes in response to a change in sales. It can be calculated using the formula:
Degree of operating leverage = Contribution margin / Operating income
Contribution margin = Selling price per bag - Variable cost per bag
To calculate the degree of operating leverage at 20,000 bags, we first need to calculate the operating income:
Operating income = Total revenue - Total cost at 20,000 bags
Next, we can calculate the degree of operating leverage using the formula mentioned earlier.
d. The degree of financial leverage measures the extent to which a company uses fixed cost financing (debt) in its capital structure. It can be calculated using the formula:
Degree of financial leverage = EBIT (Earnings Before Interest and Taxes) / Earnings Before Taxes (EBT)
To calculate the degree of financial leverage at 20,000 bags, we first need to calculate the EBIT and EBT:
EBIT = Operating income - Interest expense
EBT = Taxable income = EBIT - Interest expense
Next, we can calculate the degree of financial leverage using the formula mentioned earlier.
e. The degree of combined leverage combines the degree of operating leverage and the degree of financial leverage, providing an overall measure of the company's leverage. It can be calculated using the formula:
Degree of combined leverage = Degree of operating leverage * Degree of financial leverage
To calculate the degree of combined leverage at both sales levels (12,000 bags and 25,000 bags), we can use the degree of operating leverage and the degree of financial leverage calculated for each sales level.
By following the formulas and calculations above, you can find the specific answers to each question.