1) LDI can produce 63,000 parts per year. At this level, the degree of operating

Question

1) LDI can produce 63,000 parts per year. At this level, the degree of operating leverage is 2.85. Fixed costs are $140,000 annually. What is the operating cash flow at this level?

2) Concering diversifiable risks, which of the following statements is true? Answer from a-e below.

   I. Diversifiable risks can be essentially eliminated by investing in the market portfolio.

   II. The market rewards investors for diversifiable risk by paying a risk premium.

   III. Diversifiale risks are generally associated with an individual firm or industry.

   IV. Beta measures diversifiable risk.

       a. I and III only.

       b. II and IV only.

       c. I and IV only.

       d. II and III only.

       e. I, II, and III only.

Explanation / Answer

1.Degree of operating leverage can be calculated as follows

Degree of operating leverage = (Sales - Variable costs) / (Sales - Variable costs - Fixed Costs)

2.85 = (Sales - Variable costs) / (Sales - Variable costs - 140000)

Lets assume Sales - Variable costs as X

2.85 = X / (X - 140000)

X - 140000 = 0.35 X

0.65 X = 140000

X = 215,675.68

So Sales - Variable Costs = 215,675.68

Operating Cash flow = Sales - Variable Costs - Fixed Costs = 215,675.68 - 140,000 = 75,675.68

2. Diversifiable risk can be eliminated by investing in market portfolio. or may be more than 30 stocks, it can be eliminated. So I is true

The market will not reward the investors for diversifiable risk by paying reward. It only rewards for unsystematic risk. So II is false

Diversifiale risks are generally associated with an individual firm or industry. This is true.

Beta will not measure diversifiable risk. So IV is false

So option a is correct

only I and III are correct

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