Calculating operating leverage. TurkeyJerkey Dried Meats, Inc., had a degree of accounting operating leverage equal to 1.714 during the most recent period. If the firm's EBITDA was $4,000 and depreciation and amortization was equal to $500, then what was TurkeyJerkey's fixed cash expenses during the same period?

Question

Quizplus · Accepted Answer

Degree of operating leverage (DOL) = % change in EBITDA / % change in sales

1.714 = % change in EBITDA / % change in sales

Assume a 10% decrease in sales (which is a negative change):

1.714 = (EBITDA - (EBITDA - $500)) / (Sales - (Sales * 0.1))

1.714 = $4,500 / ($9,000 - $900)

1.714 = $4,500 / $8,100

% change in EBITDA = 21.05% (rounded)

Now, we can use the formula for DOL again to solve for fixed cash expenses (FC):

DOL = % change in EBITDA / % change in FC

1.714 = 21.05% / % change in FC

% change in FC = 12.28% (rounded)

We know that FC + variable cash expenses (VC) = total cash expenses (TC), and we know that:

EBITDA - TC = net income

$4,000 - TC = net income

We also know that:

VC = (TC - FC) / sales

VC = TC / $9,000 (assuming sales of $9,000)

VC = (TC - FC) / $9,000

Substituting the expressions for VC and net income in the formula for DOL:

DOL = (% change in net income / net income) / (% change in FC / FC)

1.714 = ((net income - (net income - (net income * 0.211))) / net income) / (0.1228)

1.714 = (0.211 / net income) / 0.1228

Solving for net income:

net income = $1,399 (rounded)

Substituting in the expression above:

$4,000 - TC = $1,399

TC = $2,601

Now, we can solve for FC:

FC + VC = TC

FC + (TC / $9,000) = $2,601

FC = $1,999

Therefore, the answer is B) $1,999.

Calculating Operating Leverage