X Ltd., has estimated that for a new product its break-even point is 2,000 units if the item is sold for Rs. 14 per unit, the cost accounting department has currently identified variable cost of Rs. 9 per unit. Calculate the degree of operating leverage for sales volume of 2500 units. If the firm wants to double up its earnings before interest and tax (EBIT), how much of a rise in sales would be needed on a percentage basis?
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Answer:
X Corporation has estimated that for a new product its break-even point is 2,000 units if theitems are sold for Rs. 14 per unit; the cost accounting department has currently identifiedvariable cost of Rs. 9 per unit. Calculate the degree of operating leverage for sales volume of2,500 units and 3,000 units. What do you infer from the degree of operating leverage at thesales volumes of 2,500 units and 3,000 units and their difference if any?Solution
Statement of Operating LeverageParticulars2500 Units3000 UnitsSales @ Rs. 14 per unit35,00042,000Variable cost22,50027,000Contribution12,50015,000Fixed cost (2000×Rs. 14–9)10,00010,000EBIT2,5005,000==EBITonContributiLeverageOperating500250012,,000500015,,=5
At the sales volume of 3000 units, the operating profit is Rs. 5,000 which is double the operatingprofit of Rs. 2,500 (sales volume of 2,500 units) because of the fact that the operating leverageis 5 times at the sales volume of 2,500 units. Hence increase of 20% in sales volume, theoperating profit has increased by 100% i.e.,5 times of 20%. At the level of 3000 units, theoperating leverage is 3 times. If there is change in sales from the level of 3,000 units, the %increase in EBIT would be three times that of % increase in sales volume.
Explanation:
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Answer:
Operating leverage is a cost-accounting formula that measures the degree to which a firm or project can increase operating income by increasing revenue. A business that generates sales with a high gross profit margin and low variable costs has high operating leverage.
At the level of 3000 units, the operating profit is Rs . 5,000, which is double of the operating profit of Rs . 2,500 ( sales volume of 2,500 units) because of the fact that the operating leverage is 5 times the sales volume of 2,500 units.
Hence, the operating profit of 20 % in sales volume has increased by 100 %, which is 5 times of 20 %. The operating leverage is 3 times at the level of 3000 units. If there is a change in sales from the level of 3,000 units, the percent increase in EBIT would be three times that of the % increase in sales volume
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