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Modern Artifacts can produce keepsakes that will be sold for $130 each. Nondepreciation fixed...

Question:

Modern Artifacts can produce keepsakes that will be sold for $130 each. Nondepreciation fixed costs are $1,600 per year, and variable costs are $80 per unit. The initial investment of $4,800 will be depreciated straight-line over its useful life of 6 years to a final value of zero, and the discount rate is 13%.

a. What is the degree of operating leverage of Modern Artifacts when sales are $7,020? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

b. What is the degree of operating leverage when sales are $13,000? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

c. Why is operating leverage different at these two levels of sales? Degree of operating leverage is when profits are what?

Degree of operating leverage:

Degree of operating leverage (DOL) is defined as the measure of the quantum of change in operating income resulting from change in sales. In other words, it measures the sensitivity of the operating income with the changes of sales.

A high DOL says that the fixed asset of the company is higher than the variable costs. So it is recommended that the company must increase the sales to manage its fixed costs.

Answer and Explanation:

Annual depreciation = $4,800/6 = $ 800

a. What is the degree of operating leverage of Modern Artifacts when sales are $7,020?

Quantity sold = $7,020/$130 = 54

Degree of Operating leverage = {eq}Q*(P-V)/[Q*(P-V) - F] {/eq}

{eq}= 54*(130-80)/[54*(130-80) -($1600+$800)] =9.0000 {/eq}

b. What is the degree of operating leverage when sales are $13,000?

Quantity sold = $713,000/$130 = 100

Degree of Operating leverage {eq}= Q*(P-V)/[Q*(P-V) - F] {/eq}

{eq}= 100*(130-80)/[100*(130-80) -($1600+$800)] =1.9231 {/eq}

c. Why is operating leverage different at these two levels of sales? Degree of operating leverage is when profits are what?

DOL is different at different sales levels.

DOL is higher when the profit is lower as $1change in sales leads to a greater percentage change in profits.


Learn more about this topic:

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Operating Cash Flow: Definition & Examples

from Finance 101: Principles of Finance

Chapter 10 / Lesson 4
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