To be profitable, a firm has recover its costs. These costs include both its fix

Question

To be profitable, a firm has recover its costs. These costs include both its fixed and its variable costs. One way that a firm evaluates at what stage it would recover the invested costs is to calculate how many units or how much in dollar sales is necessary for the firm to earn a profit. Consider the case of Dynamic Defenses Corporation: Dynamic Defenses Corporation is considering a project that will have fixed costs of $15,000,000. The product will be sold for $32.50 per unit, and will incur a variable cost of $10.75 per unit. Given Dynamic Defenses's cost structure, it will have to s689,655 units to break even on this project (QBE Dynamic Defenses's marketing and sales director doesn't think that the firm's market is big enough for the firm to break even. In fact, she believes that the firm will be able to sell only about 175,000 units. However, she also thinks that the demand for Dynamic Defenses's product is relatively inelastic (so the firm can increase the sales price without significantly decreasing the volume of product sold). Assuming that the firm can sell 175,000 units, what price must it set to break even? O $91.64 per unit O $115.75 per unit O $106.11 per unit O $96.46 per unit

Explanation / Answer

Breakeven unit = Fixed Cost / (Price - VC) = 15,000,000 / (32.5 - 10.75) = 689,655

Price = (Fixed Cost + Units x VC) / Units = (15,000,000 + 10.75 x 175,000) / 175,000 = $96.46 per unit

As can be seen in the formula here,

Increase in fixed cost => increase in breakeven units

Increase in sales price => decrease in breakeven units

Increase in debt has no impact on break-even units as interest expense is not a part of fixed costs.

Higher fixed costs means higher degree of operating leverage.

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