Healthy Foods Inc. sells 60-pound bags of grapes to the military for $15 a bag.

Question

Healthy Foods Inc. sells 60-pound bags of grapes to the military for $15 a bag. The fixed costs of this operation are $70,000, while the variable costs of grapes are $.15 per pound.

a. What is the break-even point in bags?
Answer: 15,000 bags.

b. Calculate the profit or loss (EBIT) on 10,000 bags and on 30,000 bags.
  

c. What is the degree of operating leverage at 18,000 bags and at 30,000 bags? (Round your answers to 2 decimal places.)
  

d. If Healthy Foods has an annual interest expense of $10,000, calculate the degree of financial leverage at both 18,000 and 30,000 bags. (Round your answers to 2 decimal places.)
  

e. What is the degree of combined leverage at both 18,000 and 30,000 bags? (Round your answers to 2 decimal places.)
  

Explanation / Answer

Selling Price per bag = $15

Variable Cost per pound = $0.15
Number of pound in a bag = 60

Variable Cost per bag = Variable Cost per pound * Number of pound in a bag
Variable Cost per bag = $0.15 * 60
Variable Cost per bag = $9

Contribution Margin per bag = Selling Price per bag - Variable Cost per bag
Contribution Margin per bag = $15 - $9
Contribution Margin per bag = $6

Answer a.

Breakeven Point in bag = Fixed Costs / Contribution Margin per bag
Breakeven Point in bag = $70,000 / $6
Breakeven Point in bag = 11,667

Answer b.

At 10,000 bags:

EBIT = (Selling Price per bag - Variable Cost per bag) * Number of bags sold - Fixed Costs
EBIT = ($15 - $9) * 10,000 - $70,000
EBIT = -$10,000

At 30,000 bags:

EBIT = (Selling Price per bag - Variable Cost per bag) * Number of bags sold - Fixed Costs
EBIT = ($15 - $9) * 30,000 - $70,000
EBIT = $110,000

Answer c.

At 18,000 bags:

Contribution Margin = (Selling Price per bag - Variable Cost per bag) * Number of bags sold
Contribution Margin = ($15 - $9) * 18,000
Contribution Margin = $108,000

EBIT = Contribution Margin - Fixed Costs
EBIT = $108,000 - $70,000
EBIT = $38,000

Degree of Operating Leverage = Contribution Margin / EBIT
Degree of Operating Leverage = $108,000 / $38,000
Degree of Operating Leverage = 2.84

At 30,000 bags:

Contribution Margin = (Selling Price per bag - Variable Cost per bag) * Number of bags sold
Contribution Margin = ($15 - $9) * 30,000
Contribution Margin = $180,000

EBIT = Contribution Margin - Fixed Costs
EBIT = $180,000 - $70,000
EBIT = $110,000

Degree of Operating Leverage = Contribution Margin / EBIT
Degree of Operating Leverage = $180,000 / $110,000
Degree of Operating Leverage = 1.64

Answer d.

At 18,000 bags:

Degree of Financial Leverage = EBIT / (EBIT - Interest)
Degree of Financial Leverage = $38,000 / ($38,000 - $10,000)
Degree of Financial Leverage = 1.36

At 30,000 bags:

Degree of Financial Leverage = EBIT / (EBIT - Interest)
Degree of Financial Leverage = $110,000 / ($110,000 - $10,000)
Degree of Financial Leverage = 1.10

Answer e.

At 18,000 bags:

Degree of Combined Leverage = Degree of Operating Leverage * Degree of Financial Leverage
Degree of Combined Leverage = 2.84 * 1.36
Degree of Combined Leverage = 3.86

At 30,000 bags:

Degree of Combined Leverage = Degree of Operating Leverage * Degree of Financial Leverage
Degree of Combined Leverage = 1.64 * 1.10
Degree of Combined Leverage = 1.80

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