Seminar: Corporate Finance

FABIZ, english section, Year of Study: II

Seminar: 4 -Income Statement Analysis

Breakeven point analysis
Which are the sales revenues (quantity of goods) the company has to make in order to
cover all its cost (variable and fix)?
1 - the sales revenues at breakeven point
2 - the quantity of goods at breakeven point
In order to estimate the sales revenues (quantity of goods) at breakeven point you
need to sort the companys expenses in fix and variables.
Variable expenses are those which are relied with the production process and vary when
the quantity of goods produced is changing.
The profit margin over the variable cost (expenses) will be used to cover the companys
fixed cost. If the company succeeds to cover its fixed cost, this margin will be
transformed in profit.
Degree of operating leverage
Measure the companys operating risk. High levels of this indicator indicate a high risk of
the companys operations. The companys management should keep a law level of this
indicator.
Ways of decreasing the degree of operating level:
1 - by diminishing fixed cost;
2 - by decreasing variable cost;
Short problems:
1. A manufacturer contemplates a change in technology that would reduce fixed costs
from $800,000 to $600,000, and reduce depreciation expense from $125,000 to $100,000.
However, the ratio of variable costs to sales will increase from 68% to 80%. What will
happen to break-even level of revenues?
a) A reduction to the level of $875,000.
b) A reduction to the level of $2,890,625.
c) An increase to the level of $3,500,000.
d) An increase to the level of $3,625,000.
2. For a firm with a DOL (degree of operating leverage) of 3.5, an increase in sales of 6%
will:
a) increase operating profits by 3.5%.
b) decrease operating profits by 3.5%.
c) increase operating profits by 21 %.
d) increase operating profits by 1.71%.

3. How much does each additional sales dollar contribute toward profit for a firm with $4
million break-even level of revenues and $1.2 million in fixed costs including
depreciation?
a) $0.30;
b) $0.33;
c) $0.50;
d) $0.67;
4. The degree of operating leverage of a company is 4. The companys sales are $100.000 mil.
and its fixed cost are $30.000 mil. Which is the level of the sales the company has to make in
order to get a profit of $20.000 mil.?
a) $125.000 mil. b) $ 85.000 mil.; c) $50.000 mil.; d) $140.000 mil.; e) $150.000 mil.

HOMEWORK:
1. Assume that the financial statements for Lillian's Bakery reveal that the bakery's
fixed costs are $49,000, and its variable costs per unit of production (loaf of raisin
coffee cake) are $.30. Further assume that its sales revenue is $1.00 per loaf.
Determine the quantity that has to be produced so ad Lilians Bakery reaches the
breakeven point. What is the value of sales revenues at breakeven?
2. We know the following data for BETA Co:
- sales revenues: $10,000, obtained from selling 1,000 pairs of shoes
- variable operating costs: $5,000
- depreciation: $2,000
- interests: $1,000
a) determine the operating breakeven point in quantity and sales revenues
b) If sales increase by 20% what is the value of operating leverage?
c) If sales increase with an additional 10%, what will be the increase in EBIT?