FINANCE FINAL PROJECT
MINI CASE # 1 FROM CHAPTER 12
By: Siraj Haq
SCENARIO
• I am a new hire Financial Analyst for a
highly leveraged Ski manufacturer
“SKI PALACE” in Colorado’s Rocky
Mountains.
• The company manufacturers only
one product..
State of the Art snow ski called
‘SNOOKI’
SCENARIO
• Meeting next week with CFO, Maria Sanchez
• To help her discuss the business and financial risks
with the CEO, she has asked me to prepare an
analysis focused on these 3 questions…
Q1. What is the firms break-even point in sales dollars?
Q2. If sales should increase by 30%(as president
expects), by what percentage would the EBT(earnings
before taxes) and net income increase?
Q3. Prepare another income statement using sales
with new 30% increase.
COST STRUCTURE OF THE
COMPANY
• The following information is provided.
Output level
80,000 units
Operating assets
$4,000,000
Operating asset turnover
8 times
Return on operating assets
32 %
Degree of operating leverage
6 times
Interest expense
$600,000
Tax rate
35%
WORKING PLAN?
Determine the
Break-Even Point
(BEP)
Prepare Current
Income
statement
Analyze how
EBIT, EBT and NI
change if 30%
increase in sales
Prepare
supporting
documents and
a new Income
Statement
WHAT IS A BREAK-EVEN POINT???
• The Break-even Point is the level of output (in sales
or in units) that allows the company to cover all of its
variable costs.
• The Breakeven Point (in sales dollars or units) is a
very important figure because it is this figure that
enables the manager to make a decision as to
whether or not the firm should stay in business.
WHAT IS A BREAK-EVEN POINT???
The Break Even Analysis enables the CFO:
1. Determine the quantity of output that must be sold to cover
all the operating costs
2. Calculate the EBIT , that will be achieved at various output
levels
At the break even quantity of output EBIT is equal to ZERO
OTHER IMPORTANT TERMS ???
Operating Leverage
• The level to which a company is dependent on sales of
individual products.
• A company with only a few sales has a high operating
leverage because it must use these few sales to pay its
operating expenses.
• On the other hand, a company with many sales has a low
operating leverage and may therefore sell more or fewer
products without it affecting its profitability as much
OTHER IMPORTANT TERMS ???
Fixed Costs
Costs that do no vary in total dollar amount as sales
volume or quatitiy of output changes
Ex : Administrative salaries
Depreciation
Insurance
Property taxes
Rent
OTHER IMPORTANT TERMS ???
Variable Costs
Costs that fixed amount per unit of output, but vary in
total as the output changes
Ex : Direct Labor
Direct materials
Energy costs
packaging
sales commisions
STEP 1 : WHAT IS THE REVENUE OF SKI PALACE?
Operating Asset turnover =
𝑁𝑒𝑡 𝑠𝑎𝑙𝑒𝑠
𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐴𝑠𝑠𝑒𝑡𝑠
Solving for Revenue ( Sales) gives us
Revenue ( Sales) = Operating Asset turnover * Operating Assets
Revenue ( Sales) = 8 * $4,000,000.00
Revenue ( Sales) = $32,000,000.00
STEP 2 : WHAT IS THE OPERATING PROFIT
MARGIN OF SKI PALACE?
Operating profit Margin =
Operating profit Margin =
Return on Operating Assets
Operating Asset Turnover
0.32
8
Operating profit Margin = 0.04 or 4 %
STEP 3 : WHAT IS THE EARNINGS BEFORE
INTEREST AND TAXES (EBIT) OF SKI PALACE?
EBIT = Revenue (sales) * Operating profit margin
EBIT = $32,000,000.00 * 0.04
EBIT = $1,280,000.00
STEP 4: WHAT IS THE REVENUE BEFORE FIXED
COSTS OF SKI PALACE?
Revenue before Fixed Cost = EBIT * Degree of
operating
Leverage
Revenue before Fixed Cost = $1,280,000.00 * 6
Revenue before Fixed Costs = $7,680,000.00
STEP 5: WHAT IS THE TOTAL VARIABLE COSTS
OF SKI PALACE?
Total variable cost = Revenue (sales) - Revenue
before
Fixed
Cost
Total variable cost = $32,000,000 - $7,680,000
Total Variable cost = $24,320,000.00
STEP 6: WHAT IS THE TOTAL FIXED COSTS
OF SKI PALACE?
Total Fixed cost = Revenue before - EBIT
Fixed Cost
Total Fixed cost = $7,680,000 - $1,280,000
Total Fixed cost = $6,400,000.00
STEP 7: WHAT IS THE PRICE PER UNIT OF A
A ‘SNOOKI’ BY THE SKI PALACE?
Price per unit =
𝑅𝑒𝑣𝑒𝑛𝑢𝑒 (𝑠𝑎𝑙𝑒𝑠)
𝑂𝑢𝑡𝑝𝑢𝑡 𝑙𝑒𝑣𝑒𝑙
Price per unit =
$32,000,000
80,000 𝑢𝑛𝑖𝑡𝑠
Price per Snooki = $400.00
STEP 8: WHAT IS THE VARIABLE COST PER UNIT
OF A ‘SNOOKI’ BY THE SKI PALACE?
Variable Cost per unit =
Variable Cost per unit =
𝑇𝑜𝑡𝑎𝑙 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡
𝑂𝑢𝑡𝑝𝑢𝑡 𝑙𝑒𝑣𝑒𝑙
$24,320,000.00
80,000 units
Variable Cost per Snooki = $304.00
STEP 9: WHAT IS THE BREAK-EVEN POINT IN UNITS
OF THE SKI PALACE?
Break-Even Point =
Break-Even Point =
𝑇𝑜𝑡𝑎𝑙 𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
(𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡 − 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡)
$6,400,000.00
($400 − $304)
Break-Even Point = 66,666 units
STEP10: WHAT IS THE BREAK-EVEN POINT IN SALES
OF THE SKI PALACE?
Break-Even Point =
𝑇𝑜𝑡𝑎𝑙 𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝑇𝑜𝑡𝑎𝑙 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡𝑠
(1−
)
𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝑠𝑎𝑙𝑒𝑠
$6,400,000.00
Break-Even Point =
$24,320,000.00
(1−
)
$32,000,000
Break-Even Point is sales = $ 26,666,666.67
Prepare Current
Income statement
INCOME STATEMENT 2012 SEASON
Revenue (sales)
$32,000,000.00
Variable Costs
($24,320,000.00)
Revenue before fixed Costs
$7,680,000.00
Fixed Costs
($6,400,000.00)
EBIT
$1,280,000.00
Interest Expense
($600,000)
Earnings before taxes
$680,000.00
Taxes Expense (35%)
(238,000)
Net Income
$442,000.00
Analyze how EBIT,
EBT and NI
change if 30%
increase in sales
Q2. IF SALES AT THE SKI PALACE
WERE TO INCREASE BY 30 % ?
Degree of Operating Leverage =
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐸𝐵𝐼𝑇
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑅𝑒𝑣𝑒𝑛𝑢𝑒(𝑠𝑎𝑙𝑒𝑠)
% change in EBIT = Degree of Operating Leverage * % change in Revenue(sales)
% change in EBIT = 6 * 30%
% change in EBIT = 180 %
Q2. IF SALES AT THE SKI PALACE
WERE TO INCREASE BY 30 % ?
The New Revenue(sales) = Old sales = 30 %
The New EBIT = The previous EBIT + 180 %
Revenue before fixed cost remains the same
The New EBT = The EBIT – the interest expense
The New Net Income = The new EBT – (.35 of the new EBT)
Preparing the New
Income Statement
INCOME STATEMENT WITH 30%
SALES INCREASE
Revenue (sales)
$41,600,000.00
Variable Costs
($31,616,000.00)
Revenue before fixed Costs
$9,984,000.00
Fixed Costs
($6,400,000.00)
EBIT
$3,584,000.00
Interest Expense
($600,000)
Earnings before taxes
$2,984,000.00
Taxes Expense (35%)
($1,044,400)
Net Income
$1,939,600.00
30%
180%
339%
339%
IMPORTANCE OF OPERATING LEVERAGE
• Because of the Operating leverage, any percentage
change in change in sales results in a much greater
percentage fluctuation in the EBIT and even greater in the
EBT (earnings before tax).
• Operating leverage therefore should be handled with care,
a good financial manager should be very careful when
introducing fixed costs into the capital structure.
DEGREE OF FINANCIAL LEVERAGE
Degree of Financial Leverage = EBIT / (EBIT-Interest)
Degree of Financial Leverage =
$1,280,000
($1,280,000−600,000)
Degree of Financial Leverage = 1.882
DEGREE OF COMBINED LEVERAGE
Degree of Combined Leverage =
Degree of Financial Leverage * Degree of Operating Leverage
Degree of Combined Leverage = 1.882 * 6
Degree of Combined Leverage = 11.292
DEGREE OF COMBINED LEVERAGE
USED AS PROOF
% Change in EBT = % change in sales * Degree of Combined
Leverage
% Change in EBT = 30% * 11.292 = 338.76 or 339%
As shown in the new income statement, the % change in the
New EBT is also 339%
Thus we can conclude our calculations are done correctly
THANK YOU
ANY QUESTIONS ??