Question

A project has an estimated sales price of $71 per unit, variable costs of $44.03 per unit, fixed costs of $57,000, a required return of 14 percent, an initial investment of $79,500, no salvage value, and a life of four years. Ignore taxes. What is the degree of operating leverage at the financial break-even level of output?

Answer 1

Answer: 3.09

Explanation:

Given that,

Estimated sales price = $71 per unit

Variable costs = $44.03 per unit

Fixed costs = $57,000

Required return(r) = 14 percent

Initial investment = $79,500

No. of years(n) = 4

Financial break even level of output implies that net present value equals zero and initial cost is equal to the present value of the operating cash flow.

$Initial Investment=OCF(\frac{1-[\frac{1}{(1+r)^{n} }] }{r})$

$79,500=OCF(\frac{1-[\frac{1}{(1+0.14)^{4} }] }{0.14})$

$79,500=OCF(\frac{0.4076}{0.14})$

79,500 = OCF(2.9114)

OCF = $27,306.45

$Degree\ of\ operating\ leverage = 1 + \frac{Fixed\ costs}{OCF}$

$Degree\ of\ operating\ leverage = 1 + \frac{57,000}{27,306.45}$

                                                             = 1 + 2.0874

                                                             = 3.0874

                                                              = 3.09