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You have developed the income statement for the Hugo Boss Corporation below. It represents the most recent year\'s operations, which ended yesterday. Your supervisor in the controller\'s office has just handed you a memorandum asking for written responses to the following questions: a. What is the firm\'s break-even point in sales dollars? b. If sales should increase by 30 percent, by what percent would earnings before taxes (and net income) increase? 4 6 DATA S50,439,375 25,137,000 S25,302,375 10,143,000 S15,159,375 1488,375 S13,671,000 6,835,500 S6,835,500 7 Sales 8 Variable Costs 9 Revenue before fixed costs 10 Fixed Costs 11 EBIT 12 Interest expense 13 EBT 14 Taxes 15 Net Income 16 17 SOLUTION 18 a. What is the firm\'s break-even point in sales dollars? 19 20 21 Break-even point b. If sales should increase by 30 percent, by what percent would earnings berore taxes (and net income) 22 increase? 23 24 Percent of sales increase 25 Operating leverage 26 Financial leverage 27 Combined leverage 28 Percent of earnings increase 29 30%

Solution

1)

Contribution margin = Sales - Variable costs

= 50,439,375 - 25,137,000

= $25,302,375

Contribution margin ratio = Contribution margin/Sales

= 25,302,375/50,439,375

= 50.16%

(a) Break even point (in sales dollars) = Fixed costs/ Contribution margin ratio

= 10,143,000/50.16%

= $20,221,292

(b) Sales increase by 30%

New sales = 50,439,375 x 130%

= $65,571,187

Operating leverage = Contribution/EBIT

= 25,302,375/15,159,375

= 1.67

Financial leverage = EBIT/EBT

= 15,159,375/13,671,000

= 1.11

Combined leverage = Contribution/EBT

= 25,302,375/13,671,000

= 1.85

Degree of combined leverage = % change in EBT/ % change in sales

1.85 = % change in EBT/ 30%

% change in EBT = 1.85 X 30

= 55.5%

Hence, due to 30% increase in sales, both EBT and net income will increase by 55.5%

2)

Sales = 200,000 units

Fixed cost = $300,000

Variable cost = 60% of sales

Desired earnings before interest and tax (EBIT) = $250,000

Let the selling price per unit be $K

Sales = 200,000 x K

= $200,000K

Since variable cost is 60% of sales, hence contribution margin ratio is 40%

EBIT = (Sales x Contribution margin ratio) - Fixed cost

250,000 = (200,000K x 40%) - 300,000

80,000K = 550,000

K = 550,000/80,000

= $6.875

Hence, selling price per unit = $6.875

Variable cost per unit = 6.875 x 60%

= $4.125

Income statement

Sales (200,000 x 6.875)	1,375,000
Variable cost (200,000 x 4.125)	825,000
Contribution margin	550,000
Fixed cost	300,000
EBIT	250,000