Financial leverage and break-even point
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1. Discuss the various uses for break-even analysis.
2. What factors would cause a difference in the use of financial leverage for a utility company and an automobile company?
3. Explain how the break-even point and operating leverage are affected by the choice of manufacturing facilities (labor intensive versus capital intensive).
4. What does risk taking have to do with the use of operating and financial leverage?
5. How does the interest rate on new debt influence the use of financial leverage?
6. Shock Electronics sells portable heaters for $25 per unit, and the variable cost to produce them is $17. Mr. Amps estimates that the fixed costs are $96,000.
a. Compute the break-even point in units.
b. Fill in the table below (in dollars) to illustrate that the break-even point has been achieved.
Sales ____________________
- Fixed costs ____________________
-Total variable costs ____________________
Net profit (loss) ____________________
7. Therapeutic Systems sells its products for $8 per unit. It has the following costs:
Rent $120,000 ______________________
Factory labor $1.50 per unit ______________________
Executive salaries $112,000 ______________________
Raw material $.70 per unit ______________________
Separate the expenses between fixed and variable costs per unit. Using this information and the sales price per unit of $6, compute the break-even point.
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1. Discuss the various uses for break-even analysis.
"Break even analysis:
a) Illustrates the effects of operating leverage. Break even analysis is used to find the braek even units for different levels of fixed costs. Thus it illustrates the effects of operating leverage. Operating leverage is the use of fixed operating costs by the firm to increase EBIT.
b) is useful for forecasting the profitability of a firm, division or product line. If the firm is selling above the break even point it is earning profits.
c) is useful for analyzing the impact of changes in fixed costs, variable costs, and sales price. Break even analysis can be used to study the sensitivity of profits to different levels of fixed costs, varaible costs and sales price.
"
2. What factors would cause a difference in the use of financial leverage for a utility company and an automobile company?
"Financial leverage occurs when by using fixed cost financing, a small change in operating income is magnified into a larger change in earnings per share. But there is a risk involved as leverage magnifies both profits and losses. Thus a decrease in operating income can be magnified into a larger decrease in earnings per share.
An automobile comapnay has higher variability in sales and hence a higher variability in operating income when compared to a utility company. Thus the risks for an automobile company are higher and therefore it will use lesser financial leverage than a utility company.
"
3. Explain how the break-even ...
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