"12. The Harmon Company manufactures skates. The company’s income statement for 2008 isas follows:HARMON COMPANYIncome StatementFor the Year Ended December 31, 2008Sales (30,000 skates @ $25) ......................................................... $750,000 Less: Variable costs (30,000 skates at $7) ................................. 210,000 Fixed costs ........................................................................ 270,000Earnings before interest and taxes (EBIT) .................................... 270,000Interest expense ............................................................................. 170,000Earnings before taxes (EBT) ......................................................... 100,000Income tax expense (35%) ............................................................ 35,000Earnings after taxes (EAT)............................................................ $ 65,000Given this income statement, compute the following: a. Degree of operating leverage. b. Degree of financial leverage. c. Degree of combined leverage. d. Break-even point in units.S5-13 5-12. Solution:Harmon CompanyQ = 30,000, P = $25, VC = $7, FC = $270,000, I = $170,000Q(P - VC) a.DOL = Q(P-- VC) FC 30,000($25 - $7) = 30,000($25- $7)- $270,000 30,000($18) = 30,000($18) - $270,000 $540,000 $540,000 = = = 2x $540,000 - $270,000 $270,000 EBIT $270,000 b. DFL = = EBIT- I $270,000- $170,000 $270,000 = = 2.7x $100,000 Q(P - VC) c.DCL = Q(P- VC)-- FC I 30,000($25 - $7) =30,000($25- $7)- $270,000- $170,000 30,000($18) $540,000 = = = 5.4x 30,000($18) - $440,000 $100,000 $270,000 d.BE = =15,000 units $25 - $7 S5-14 13. Healthy Foods, Inc. sells 50-pound bags of grapes to the military for $10 a bag. The fixedcosts of this operation are $80,000, while the variable costs of the popcorn are $.10 per pound. a. What is the break-even point in bags? b. Calculate the profit or loss on 12,000 bags and on 25,000 bags. c. What is the degree of operating leverage at 20,000 bags and at 25,000 bags?Why does the degree of operating leverage change as the quantity sold increases? d. If Healthy Foods has an annual interest expense of $10,000, calculate the degree offinancial leverage at both 20,000 and 25,000 bags. e. What is the degree of combined leverage at both sales levels?5-13. Solution:Healthy Foods, Inc.$80,000 $80,000 a. BE = = =16,000 bags$10-× ($.10 50) $5 b. 12,000 bags 25,000 bags Sales @ $10 per bag $120,000 $250,000 Less: Variables Costs ($5)(60,000) (125,000)Fixed Costs(80,000) (80,000) Profit or Loss ($ 20,000) $ 45,000Q(P - VC) c. DOL = Q(P-- VC) FC 20,000($10 - $5)DOL at 20,000 =20,000 ($10-- $5) $80,000 $100,000 = = 5.00x $20,00 25,000 ($10 - $5) DOL at 25,000 = 25,000($10-- $5) $80,000 $125,000 = = 2.78x $45,000 Leverage goes down because we are further away from thebreak-even point, thus the firm is operating on a larger profitbase and leverage is reduced.S5-15 5-13. (Continued)EBIT d. DFL =EBIT - I First determine the profit or loss (EBIT) at 20,000 bags. Asindicated in part b, the profit (EBIT) at 25,000 bagsis $45,000: 20,000 bagsSales @ $10 per bag $200,000Less: Variable Costs ($5) 100,000 Fixed Costs 80,000Profit or Loss $ 20,000$20,000 DFL at 20,000 = $20,000 - $10,000 = 2.0x $45,000 DFL at 25,000 = $45,000 - $10,000 =1.29x Q (P - VC) e. DCL =Q(P- VC) --FC I 20,000 ($10 - $5) DCL at 20,000 =20,000($10-- $5) $80,000- $10,000 $100,000 = =10.0x $10,000 25,000 ($10 - $5) DCL at 25,000 = 25,000($10-- $5) $80,000- $10,000 $125,000 = = 3.57x $35,000 S5-16 14. U.S. Steal has the following income statement data:Total OperatingUnits Variable FixedTotal Total IncomeSold Costs Costs Costs Revenue (Loss)40,000 $80,000 $50,000 $130,000 $160,000 $30,00060,000120,00050,000170,000240,00070,000 a. Compute DOL based on the formula below (see page 128 for an example):Percent change in operating incomeDOL =Percent change in units soldb. Confirm that your answer to part a is correct by recomputing DOL using formula 5–3 on page___. There may be a slight difference due to rounding.Q(P - VC)DOL =Q (P- VC)- FC Q represents beginning units sold (all calculations should be done at this level). P canbe found by dividing total revenue by units sold. VC can be found by dividing totalvariable costs by units sold.5-14. Solution:U. S. StealPercent change in operating income a.DOL = Percent change in units sold ? $40,000? ? ? 30,000 133% ? ? = = = 2.66 20,000 ?? 50% ?? 40,000 ?? S5-17 "