Break even-operating leverage


Part I:

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Cash Budget

For Company X, actual sales for November and December, and projected sales for January through August are as follows:

Actual sales    Projected sales
Nov    225,000    Jan    105,000    May    280,000
Dec    180,000    Feb    115,000    Jun    255,000
Mar    135,000    Jul    240,000
Apr    255,000    Aug    165,000

Company X collects 25% of its sales in cash at the time of sale; 50% of sales is collected in the month following the sale; and the remaining 25% is collected in the second month after the sale.

Raw materials are purchased on credit two months ahead of expected sales, at a cost equal to 75% of the expected sales; the purchases are paid for one month after the purchase. For example, purchases for March sales are made in January, and paid for in February.

The Company pays $10,000 per month for rent, and $20,000 per month for other expenses. Quarterly tax payments of $23,000 are due in March and June.

The Company's cash balance on December 31 was $22,000; the Company's policy requires a minimum cash balance of $20,000 each month. Anytime the cash balance will fall below the minimum, the Company will use short-term financing to maintain the minimum. This financing carries interest of 12% per year (i.e. 1% per month). Borrowing occurs at the beginning of the month in which it will be needed, and interest will be paid in the month after it is incurred. For example, if the Company will need an additional $30,000 in March to maintain the minimum balance, that amount will be borrowed on Mar 1; therefore, the Company will owe $300 in interest for the month of March; this interest will be paid in April. Assume that any short-term financing will be repaid in the first month in which there is additional cash available.

1. Prepare a cash budget for Company X covering January through July.

2. Company X has $150,000 in notes payable due in July that must be repaid or renegotiated for an extension. Will the Company have enough cash in July to repay the notes?

Part II: Time Value of Money:

Be sure to show how you determine the answers to the Time Value of Money problems.

Q1. What will be the future value of the following investments?

a) $3,000 invested for 10 years at 8% interest compounded annually
b) $7,000 invested for 9 years at 7% interest compounded annually
c) $900 invested for 11 years at 10% interest compounded annually
d) $20,000 invested for 5 years at 4% interest compounded annually

Q2. What is the present value of the following future amounts?

a) $700 to be received 9 years from now discounted back to the present at 8%
b) $300 to be received 4 years from now discounted back to the present at 5%
c) $900 to be received 7 years from now discounted back to the present at 4%
d) $800 to be received 8 years from now discounted back to the present at 19%

Q3. What is the future value of the following annuities?

a) $400 per year for 9 years compounded annually at 5%
b) $200 per year for 4 years compounded annually at 10%
c) $85 per year for 7 years compounded annually at 6%
d) $75 per year for 2 years compounded annually at 1%

Q4. What is the present value of the following annuities?

a) $2,000 per year for 9 years discounted back to the present at 7%
b) $100 per year for 5 years discounted back to the present at 2%
c) $200 per year for 7 years discounted back to the present at 6%
d) $500 per year for 8 years discounted back to the present at 9%

Part III: Break-Even/Operating Leverage

Be sure to show how you determine the answers to these problems.

Use the following information to answer the questions below:

                                           Company A    Company B    Company C
average selling price per unit    20.00             300.00            50.00
average variable cost per unit   15.50             200.00            18.00
units sold                                85,000             4,500            15,000
fixed costs                              45,000           100,000           70,000

a) What is the profit for each company at the indicated sales volume?
b) What is the break-even point in units for each company?
c) What is the degree of operating leverage for each company at the indicated sales volume?
d) If sales were to decline, which company would suffer the largest relative decline in profitability?

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Finance Basics: Break even-operating leverage
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