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Foundations of Financial Managem
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Operating and Financial Leverage
Problem 5-4 Problem 5-11
Spreadsheet Templates by Block, Hirt and Danielsen
Copyright © 2011 McGraw-Hill/Irwin and ANSRSource. (www.ansrsourceindi
emplates
ial Management
HAPTER 5
cial Leverage
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Foundations of Financial Management
Block, Hirt and Danielsen
Problem 5-4
Objective: Break-even analysis
Student Name:
Course Name:
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Draw two break-even graphs–one for a conservative firm using labor-intensive production and another for a
capital-intensive firm. Assuming these companies compete within the same industry and have identical sales,
explain the impact of changes in sales volume on both firms' profits.
Based on the following assumtions draw two break-even graphs.
Labor Capital
Intensive Intensive
Selling price $12.00 $12.00
Variable cost per unit $8.00 $5.00
Fixed costs $200,000 $300,000
Copyright © 2011 McGraw-Hill/ Irwin Spreadsheet Template by Block, Hirt and Danielsen Problem: 5-4
Solution
Problem 5-4
Instructions
Select the appropriate range required to draw the graph.
Complete the tables below for both the Labor-Intensive and capital-intensive firms.
Labor-Intensive Company
Units 0 25,000 50,000 75,000 100,000
Total Revenue $0 $300,000 $600,000 $900,000 $1,200,000
Variable costs $0 $200,000 $400,000 $600,000 $800,000
Contribution margin $0 $100,000 $200,000 $300,000 $400,000
Fixed Costs $200,000 $200,000 $200,000 $200,000 $200,000
Total Costs $200,000 $400,000 $600,000 $800,000 $1,000,000
Profit $200,000 $100,000 $0 $100,000 $200,000
Revenus and costs
Labor-Intensive Company
$1,400,000
$1,200,000
$1,000,000
Total Revenue
$800,000
Fixed costs
$600,000 Total costs
$400,000
$200,000
$0
0 25,000 50,000 75,000 100,000
Units produced and sold
Copyright © 2011 McGraw-Hill/ Irwin Spreadsheet Template by Block, Hirt and Danielsen Problem: 5-4
Capital-Intensive Company
Units 0 25,000 50,000 75,000 100,000
Total Revenue $0 $300,000 $600,000 $900,000 $1,200,000
Variable costs $0 $125,000 $250,000 $375,000 $500,000
Contribution margin $0 $175,000 $350,000 $525,000 $700,000
Fixed Costs $300,000 $300,000 $300,000 $300,000 $300,000
Total Costs $300,000 $425,000 $550,000 $675,000 $800,000
Profit $300,000 $125,000 $50,000 $225,000 $400,000
Revenus and costs
Capital-Intensive Company
$1,400,000
$1,200,000
$1,000,000
Total Revenue
$800,000
Fixed costs
$600,000 Total costs
$400,000
$200,000
$0
0 25,000 50,000 75,000 100,000
Units produced and sold
Explain the impact of changes in sales volume on both firms' profits.
The company having the high fixed costs will have lower variable costs than its competitor since it has
substituted capital for labor. With a lower variable cost, the high fixed cost company will have a larger contribution
margin. Therefore, when sales rise, its profits will increase faster than the low fixed cost firm and when the sales
decline, the reverse will be true.
Copyright © 2011 McGraw-Hill/ Irwin Spreadsheet Template by Block, Hirt and Danielsen Problem: 5-4
Foundations of Financial Management
Block, Hirt and Danielsen
Problem 5-11
Objective: Degree of leverage
Student Name:
Course Name:
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The Harding Company manufactures skates. The company’s income statement for 2010 is as follows:
HARDING COMPANY
Income Statement
For the Year Ended December 31, 2010
Sales (10,000 skates @ $50 each) $500,000
Less: Variable costs (10,000 skates at $20) 200,000
Fixed costs 150,000
Earnings before interest and taxes (EBIT) 150,000
Interest expense 60,000
Earnings before taxes (EBT) 90,000
Income tax expense (40%) 36,000
Earnings after taxes (EAT) $54,000
Given this income statement, compute the following:
a. Degree of operating leverage.
b. Degree of financial leverage.
c. Degree of combined leverage.
d. Break-even point in units (number of skates).
Copyright © 2011 McGraw-Hill/ Irwin Spreadsheet Template by Block, Hirt and Danielsen Problem: 5-11
Solution
Problem 5-11
Instructions
Using the Income Statement (above) and the information (below), compute the degree of operating leverage,
degree of financial leverage, degree of combined leverage, and the break-even point in units.
Information:
Unit sales 10,000
Selling price $50
Variable cost per unit $20
a. Degree of operating leverage 2.00 times
b. Degree of financial leverage 1.67 times
c. Degree of combined leverage 3.33 times
d. Break-even point in units 5,000 skates
Copyright © 2011 McGraw-Hill/ Irwin Spreadsheet Template by Block, Hirt and Danielsen Problem: 5-11
