"6. Shawn Penn & Pencil Sets, Inc., has fixed costs of $80,000. Its product currently sells for $5 perunit and has variable costs of $2.50 per unit. Mr. Bic, the head of manufacturing, proposes tobuy new equipment that will cost $400,000 and drive up fixed costs to $120,000. Although theprice will remain at $5 per unit, the increased automation will reduce costs per unit to $2.00.As a result of Bic’s suggestion, will the break-even point go up or down? Compute thenecessary numbers.5-6. Solution:Shawn Penn & Pencil Sets, Inc.$80,000 $80,000 BE (before) = = = 32,000 units$5.00 - $2.50 $2.50 $120,000 $120,000 BE (after) = = = 40,000 units$5.00 - $2.00 $3.00 The break-even point will go up.7. Jay Linoleum Company has fixed costs of $70,000. Its product currently sells for $4 per unit andhas variable costs per unit of $2.60. Mr. Thomas, the head of manufacturing, proposes to buynew equipment that will cost $300,000 and drive up fixed costs to $105,000. Although the pricewill remain at $4 per unit, the increased automation will reduce variable costs per unit to $2.25.As a result of Thomas’s suggestion, will the break-even point go up or down? Computethe necessary numbers.5-7. Solution:Jay Linoleum Company$70,000 $70,000 BE (before) = = = 50,000 units$4.00 - $2.60 $1.40 $105,000 $105,000 BE (after) = = = 60,000 units$4.00 - $2.25 $1.75 The break-even point will go up.S5-8 8. Gibson & Sons, an appliance manufacturer, computes its break-even point strictly on thebasis of cash expenditures related to fixed costs. Its total fixed costs are $1,200,000, but25 percent of this value is represented by depreciation. Its contribution margin (price minusvariable cost) for each unit is $2.40. How many units does the firm need to sell to reachthe cash break-even point?5-8. Solution:Gibson & SonsCash related fixed costs = Total Fixed Costs – Depreciation= $1,200,000 – 25% ($1,200,000)= $1,200,000 – $300,000= $900,000$900,000 BE = = 375,000 units$2.40 9. Air Purifier, Inc., computes its break-even point strictly on the basis of cash expendituresrelated to fixed costs. Its total fixed costs are $2,400,000, but 15 percent of this value isrepresented by depreciation. Its contribution margin (price minus variable cost) for eachunit is $30. How many units does the firm need to sell to reach the cash break-even point?5-9. Solution:Air Purifier, Inc.Cash related fixed costs = Total Fixed Costs – Depreciation= $2,400,000 – 15% (2,400,000)= $2,400,000 – $360,000= $2,040,0002,040,000 BE = = 68,000 units$30 S5-9 10. Draw two break-even graphs—one for a conservative firm using labor-intensive productionand another for a capital-intensive firm. Assuming these companies compete within thesame industry and have identical sales, explain the impact of changes in sales volume onboth firms’ profits.5-10. Solution:Labor-Intensive and capital-intensive break-even graphsLabor-Intensive Capital-Intensive Total revenue Total revenue Revenue and costs Revenue and costs Total Total costs costs Profits Profits BE Variable BE Variable Cost Cost Fixed costs Fixed costs Units produced and sold Units produced and sold The company having the high fixed costs will have lowervariable costs than its competitor since it has substituted capitalfor labor. With a lower variable cost, the high fixed cost companywill have a larger contribution margin. Therefore, when salesrise, its profits will increase faster than the low fixed cost firmand when the sales decline, the reverse will be true.S5-10 11. The Sterling Tire Company’s income statement for 2008 is as follows:STERLING TIRE COMPANYIncome StatementFor the Year Ended December 31, 2008Sales (20,000 tires at $60 each)...................................$1,200,000 Less: Variable costs (20,000 tires at $30) ..............600,000 Fixed costs .................................................... 400,000Earnings before interest and taxes (EBIT) ..................200,000Interest expense ........................................................... 50,000Earnings before taxes (EBT) .......................................150,000Income tax expense (30%) .......................................... 45,000Earnings after taxes (EAT)..........................................$105,000Given 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.5-11. Solution:Sterling Tire CompanyQ = 20,000, P = $60, VC = $30, FC = $400,000, I = $50,000Q(P - VC) a.DOL = Q(P-- VC) FC 20,000($60 - $30) = 20,000($60-- $30) $400,000 20,000($30) = 20,000($30) - $40,000 $600,000 $600,000 = = = 3.00x $600,000 - $400,000 $200,000 S5-11 5-11. (Continued) EBIT $200,000 b. DFL = = EBIT- I $200,000- $50,000 $200,000 = =1.33x $150,000 Q (P - VC) c.DCL = Q(P- VC)-- FC I 20,000($60 - $30) =20,000($60-- $30) $400,000- $50,000 $600,000 $600,000 = = = 4x $600,000- $400,000- $50,000 $150,000 $400,000 $400,000 d. BE = = =13,333 units$60 - $30 $30 S5-12 "