ESSEN OF INVESTMENTS CONNECT AC
ESSEN OF INVESTMENTS CONNECT AC
11th Edition
ISBN: 9781266650314
Author: Bodie
Publisher: MCG
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Chapter 12, Problem 33C
Summary Introduction

(a)

To compute:

The percentage decline in sales, if the economy enters a recession, for the Ocean gate who sells hard drives for $200 each, fixed costs are $30 millions and variable costs are $140 millions, and corporate tax is 30% .

Introduction:

Operating leverage means a relationship between fixed and variable costs. A business which has a higher contribution margin and lower variable cost have high operating leverage.

If the economy enters s recession, then, the prices of product get high and sales starts a decline.

Expert Solution
Check Mark

Answer to Problem 33C

The percentage decline in sales is 100% at the time of recession.

Explanation of Solution

Given:

At the time of recession, it will sell only half of the sale volume.

Sales in a strong economy is 2 millions

Sales in recession is 1 million

Sale price per unit is $200

If the economy enters a recession, then, the prices of product get high and sales starts declining.

Here,

In a recession,

  Sales=1 million×$200=$200 millions

In a strong economy,

  Sales=2 millions×$200=$400 millions

Hence,

  % change in sales=$400 millions$200 millions$200 millions×100=100%

So, percentage decline in sales is 100% .

Summary Introduction

(b)

To determine:

The percentage decline in sales, if the economy enters a recession, for the Ocean gate who sells hard drives for $200 each, fixed costs are $30 millions and variable costs are $140 millions, and corporate tax is 30% .

Introduction:

Operating leverage means a relationship between fixed and variable costs. A business which has a higher contribution margin and lower variable cost have high operating leverage.

The economy drops down at the time of recession. So, the profit with high operating leverage firm will reduce drastically.

Expert Solution
Check Mark

Answer to Problem 33C

The percentage decline in profits is 200% at the time of recession.

Explanation of Solution

Given:

At the time of recession, it will sell only half of the sale volume.

Sales in a strong economy is 2 millions

Sales in recession is 1 million

Sale price per unit is $200

Variable cost per unit is $140

Fixed Cost is $30 millions

Corporate tax is  30%

If the economy enters recession prices of product gets high and profit will get reduced.

Here,

In a recession economy,

  Sales=1 million×$200=$200 millions

  Total Cost=$30 millions+1 million×$140=$170 millions

  Profit before tax=$200 millions$170 millions=$30 millions

In a strong economy,

  Sales=2 millions×$200=$400 millions

  Total Cost=$30 millions+2 millions×$140=$310 millions

  Profit before tax=$400 millions$310 millions=$90 millions

Now,

  % change in sales=$90 millions$30 millions$30 millions×100=200%

So, percentage decline in profit is 200% .

Summary Introduction

(c)

To determine:

By comparing decline in sales and decline in profits, measure the operating leverage of the Ocean gate who sells hard drives for $200 each, fixed costs are $30 millions and variable costs are $140 millions, and corporate tax is 30% .

Introduction:

Operating leverage means a relationship between fixed and variable costs. A business which has a higher contribution margin and lower variable cost have high operating leverage.

Expert Solution
Check Mark

Answer to Problem 33C

The operating leverage of the firm is high as change in profit is higher than the change in sales.

Explanation of Solution

  Operating Leverage=% change in profit% change in sales×100=200%100%=2

So, operating leverage of firm is 2

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Financial leverage explained; Author: The Finance story teller;https://www.youtube.com/watch?v=GESzfA9odgE;License: Standard YouTube License, CC-BY