OceanGate sells external hard drives for $400 each. Its total fixed costs are $6
ID: 2735946 • Letter: O
Question
OceanGate sells external hard drives for $400 each. Its total fixed costs are $60 million, and its variable costs per unit are $240. The corporate tax rate is 30%. If the economy is strong, the firm will sell 7 million drives, but if there is a recession, it will sell only half as many. a. What is the firms' degree of operating leverage (defined as the ratio of the percent change in EBIT to the percent change in sales)? Degree of operating leverage b. If the economy enters a recession, what will be the firm’s after-tax profit?
Explanation / Answer
b.
If the economy enters a recession, the firm’s after-tax profit will be:
= (3.5×400)m - 60m - (3.5×240)
=500m(1-.30)
=350m
a.
First find if the economy is strong , the firm’s after-tax profit will be:
= (7×400)m - 60m - (7×240)
=1060m(1-.30)
=742 m
Operating leverage:
=%change in earnings/%change in sales
=[(742-350)/350]/[(2800-1400)/1400]
=1.12/1
=1.12
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