The firm’s “cost structure” for the above question is primarily (circle one: VARIABLE FIXED What is the expected profit/loss for the period? Create an Inc Stmt using the full CM format (Ignore taxes). Based on the above Income Statement prepared, what is the current “Operating Leverage” and what dollar amount and percentage increase in profits would be expected with say a 10% increase in unit sales? Show your work and prepare a new CM income stmt (template) below to confirm (prove) your answer. Considering the formula for “Operating Leverage”, if no fixed costs had existed in the above fact pattern, operating leverage would have been (i.e, would always be): a. Negative b. Zero c. 1.0 d. > 2.0 If the level of activity (X) increases, within the relevant range of activity (i.e. class pizza example) a Variable cost per unit will increase b. Total fixed costs will increase C. Total costs will actually decrease d. Fixed cost per unit will increase e. Total variable costs will increase

## Expert Answer

11 | |||||||||

Given | |||||||||

Sales | 300000 | 210000/.70*1 | |||||||

Variable Cost | 30% | 90000 | 210000/.70*.30 | ||||||

Contribution | 210000 | 210000 | |||||||

Fixed Cost | 340000 | 210000+130000 | |||||||

Loss | -130000 | -130000 | |||||||

Unit Basis | % | Total dollars | |||||||

SP | 100 | 100.00% | 300000 | ||||||

VC | 30 | 30.00% | 90000 | ||||||

CM | 70 | 70.00% | 210000 | ||||||

FC | 113.33 | 113.33% | 340000 | ||||||

Loss | -43.33 | -43.33% | -130000 | ||||||

11a | The firm cost structure is variable. | ||||||||

12 | |||||||||

Unit Basis | % | Total dollars | |||||||

SP | 30 | 100.00% | 1200000 | 30*40000 | |||||

VC | 27 | 90.00% | 1080000 | 27*40000 | |||||

CM | 3 | 10.00% | 120000 | SP-VC | |||||

FC | 2.75 | 9.17% | 110000 | given | |||||

Profit | 0.25 | 0.83% | 10000 | CM- FC | |||||

13 | |||||||||

Operating Leverage | CM/ Income | ||||||||

120000/10000 | |||||||||

12 | |||||||||

10% increase in unit sales | |||||||||

40000*110% | 44000 | ||||||||

Unit Basis | % | Total dollars | |||||||

SP | 30 | 100.00% | 1320000 | 30*44000 | |||||

VC | 27 | 90.00% | 1188000 | 27*44000 | |||||

CM | 3 | 10.00% | 132000 | SP-VC | |||||

FC | 2.50 | 8.33% | 110000 | same | |||||

Profit | 0.50 | 1.67% | 22000 | CM- FC | |||||

% increase in profit is 1.67% – 0.83% = 0.84% | |||||||||

14 | |||||||||

if there were no fixed cost, Operating leverage will be zero. | |||||||||

answer is option b | |||||||||

15 | |||||||||

if level of activity increases within a range the total variable cost will increase. | |||||||||

answer is option d. | |||||||||

For your undertanding: | |||||||||

this you can see above in part 13, where there was 10% increase, the total variable cost increased. | |||||||||

option a, Per unit VC was same it did not increase. | |||||||||

Total fixed cost was same it did not increase | |||||||||

Total cost increased it did not decrease | |||||||||

fixed cost per unit decrease it did not increase | |||||||||

so last option e is correct |