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Break Even And Leverage Analysis

  Break Even and Leverage Analysis

Illustration 57

Let us assume a Magazine publishing company. The aggregate fixed cost occurred is $10,000. Variable Cost occurred per magazine copy on printing paper, royalty etc. is equal to $10 per copy. Presume if the magazine is fixed $20 per copy, what is the break even number of copies of the magazine printed and sold?

Solution

It is unambiguous from the problem that the

                        Total Fixed Cost                     =          $10,000

                        Average Variable Cost            =          $10

                        Price Fixed per copy               =          $20

                        Break Even Volume                =             TFC 
                                                                                  P – AVC

                                                VB                  =          10000
                                                                                  20 – 10

                                                                     =       1000 Copies

Therefore, 1000 copies of the magazine denote the break even productivity and sales of the magazine. That is if the publisher manufactures and is capable to sell 1000 copies, he will accomplish no profits no loss condition.

Illustration 58

If for instance let us assume a mobile manufacturing company estimates to sell less than 500 mobiles a week, which will incur loss. Consequently, the manufacturer may regard cutting manufacturing costs and reducing advertising expenses etc so as to break even or even accomplish some profits. Also he may fix higher prices to set right the loss incurred.

Now in the event if he fixes prices equal to $7000 per mobile, his costs such as Total Fixed cost to $1,000,000 and Average Variable cost to $5000 and sells, compute the new break even sales of the mobile.

Solution

Break Even Volume of Sales

                                                V’B     =              TFC            
                                                                        P’ – AVC

                                                         =            1,000,000                 
                                                                        7000 – 5000

                                                         =          500 mobiles

Now, the mobile units to be sold are 500 which as per the mobile manufacturer will have no profit no loss condition.

Illustration 59

Presume the magazine publishing company has a profit aim of making $20000 from the magazines, then compute the necessary volume of sales to realise the target amount of profits of $20000. All the other costs as in the illustration 57; i.e. TFC = 10000, AVC = 10 and price per magazine be $20.

Solution

                                    TFC + π
                                    P – AVC

                        =          10000 + 20000
                                            20 – 10

                        =          30000 / 10       =          3000 Copies.

Thus, if the publisher is able to sell 3000 copies, he will gain back the total fixed cost and average variable costs along with accomplishing profits of $20000. His profits will become more if his sales surpass 3000 copies.

Illustration 60

Compute the degree of Operating Leverage from our above illustration of obtaining level of productivity necessary to yield a target amount of profits. In our case the fixed cost is $10000, price as $20 and AVC as $10 and the degree of productivity necessary to gain back fixed cost and provide for profits of $20000 was obtained to be 3000 copies.

Now with this information, ascertain the degree of operating leverage.

Solution

            Degree of Operating Leverage is computed with the following formula.

                        DOL    =               Q (P - AVC)                     
                                                Q (P – AVC) – TFC

            Here,               Q         =          3000 copies
                                   
                                    =                 3000 (20 – 10)                 
                                                3000 (20 – 10) – 10000

                                    =          30000  =          1.5
                                                20000

Now, if the industry becomes more highly leveraged, the total fixed cost will enhance and average variable cost will decrease consequents in huger productivity to gain back fixed cost and to capitulate besieged profits. This will tend to the greater degree of operating leverage DOL.

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