Sources of Operating Leverage
1.What are the sources of operating leverage and financial leverage and explain their impact on operating and net income?
2.Mini Case: Your organization (a not for profit group) is considering hiring a professional fund raise to assist in selling raffle tickets. This consultant is going to charge $10,000 (fixed cost) plus 45 cents (variable cost) for every person solicited. It is going to try to get donations of $5 per raffle ticket sold. In this case, break even would be just about 2,200 tickets sold. Your mailing list contains 5,000 names. Your organization must now decide how many tickets it is likely to sell. Remember if it sells less than 2,200 it makes no money. Should it undertake this project? State the assumptions that you made in arriving at your answer and defend your decision. Consider two industries, steel production and donut making. Which industry do you think has the highest degree of operating leverage? Give your answer to the first part, what should the level of financial leverage for each industry? Should both of these industries have similar degrees of combined leverage?
3.High degrees of financial leverage and operating leverage each involve different types of risk. Risk of what?
4.Study Problem #1 ( Leverage analysis) You have developed the following analytical income statment for Hugo boss Corporation. It represents the most recent year’s operations, which ended yesterday. Then redo part d with 10% reduction in variable cost and a $3000 increase in fixed cost.
Varible Costs ( 25,137,000)
Revenue before Fixed Costs $25,302,375
Fixed Costs (10,143,000)
Interest Expense (1,488,375)
Earnings before taxes $13,671,000
Taxes at 50% (6,835,500)
Net Income $6,835,500
Your supervisor in the controller’s office has just handed you a memorandm asking for written responses to the following question:
A. At this level of output, what is the degree of operating leverage?
b. What is the degree of financial leverage?
C. What is the combined leverage?
D. What is the firms’ break-even point in sales dollars?
E. If sales should increase by 30%, by what percent would earnings before taxes(and net income) increase?
My textbook for this course is Keown, Martin, Petty, Scott,JR. Foundations of Finance Fifth Edition