Thad Morgan, a motorcycle enthusiast, has been exploring the possibility of relaunching the Western Hombre brand of cycle that was popular in the 1930s. The retro-look cycle would be sold for $17,000 and at that price, Thad estimates 700 units would be sold each year. The variable cost to produce and sell the cycles would be $13,600 per unit. The annual fixed cost would be $1,785,000.

(a) What is the break-even in unit sales?
(b) What is the margin of safety in dollars?
(c) What is the degree of operating leverage? (Round your answer to 2 decimal places.)

(a) 525 units

(b) $2,975,000

(c) 4

Explanation:

(a) Break-even in unit sales:

= Fixed cost ÷ (Selling value of retro-look cycle - Variable cost of retro-look cycle)

= $1,785,000 ÷ ($17,000 - $13,600)

= $1,785,000 ÷ $3,400

= 525 units

(b) Margin of safety in dollars:

= (Selling value of retro-look cycle × Estimated units sold) - (Selling value of retro-look cycle × Break-even in unit sales)

= ($17,000 × 700 units) - ($17,000 × 525 units)

= $11,900,000 - $8,925,000

= $2,975,000

(c) Contribution:

= (Selling value of retro-look cycle × Estimated units sold) - (Variable cost of retro-look cycle × Estimated units sold)

= ($17,000 × 700) - ($13,600 × 700)

= $11,900,000 - $9,520,000

= $2,380,000

PBIT:

= Contribution - Annual fixed cost

= $2,380,000 - $1,785,000

= $595,000

Degree of operating leverage:

= Contribution ÷ PBIT

= $2,380,000 ÷ $595,000

= 4

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