Exercise 12.1.Breakeven Analysis, DOL, DTL, EBIT Sensitivity

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Exercise 12.1.?Breakeven Analysis, DOL, DTL, EBIT Sensitivity
LED Pencil, Inc. is evaluating two different operating structures: one with high fixed costs and low variable costs and another with low fixed costs and high variable costs. The characteristics of the two operating structures are outlined below. The firm has annual interest expense of $100,060, a tax rate of 40%, and 50,000 shares of common stock outstanding.
Fixed Costs Sales Price per Unit Variable Cost per Unit
Operating Structure A $750,000 $45 $10
Operating Structure B $340,000 $45 $20
a. For each operating structure, calculate:
1. Sales, variable costs, earnings before interest and taxes (EBIT), and earnings per share (EPS) for sales of 25,000, 35,000, and 45,000 units, respectively.
2. The degree of operating leverage (DOL) and degree of total leverage (DTL) if sales drop from 35,000 units to 25,000 units.
3. The operating breakeven point in units.
b. Which operating structure has greater operating leverage and business risk?
c. Graph the two operating structures separately on cost/revenue and units sold axes.
d. Which operating structure is recommended if LED Pencil, Inc. projects sales of
1. 20,000 units
2. 50,000 units
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Exercise 12.1.Breakeven Analysis, DOL, DTL, EBIT Sensitivity

/in /by
Exercise 12.1.?Breakeven Analysis, DOL, DTL, EBIT Sensitivity
LED Pencil, Inc. is evaluating two different operating structures: one with high fixed costs and low variable costs and another with low fixed costs and high variable costs. The characteristics of the two operating structures are outlined below. The firm has annual interest expense of $100,060, a tax rate of 40%, and 50,000 shares of common stock outstanding.
Fixed Costs Sales Price per Unit Variable Cost per Unit
Operating Structure A $750,000 $45 $10
Operating Structure B $340,000 $45 $20
a. For each operating structure, calculate:
1. Sales, variable costs, earnings before interest and taxes (EBIT), and earnings per share (EPS) for sales of 25,000, 35,000, and 45,000 units, respectively.
2. The degree of operating leverage (DOL) and degree of total leverage (DTL) if sales drop from 35,000 units to 25,000 units.
3. The operating breakeven point in units.
b. Which operating structure has greater operating leverage and business risk?
c. Graph the two operating structures separately on cost/revenue and units sold axes.
d. Which operating structure is recommended if LED Pencil, Inc. projects sales of
1. 20,000 units
2. 50,000 units
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