Problem 1: Break-Even
Dime a dozen diamonds makes synthetic diamonds by treating carbon. Each diamond can be sold for $100. The materials cost for a standard diamond is $30. The fixed cost incurred each year for factory upkeep and administrative expenses are $200,000. The machinery cost $1 million and is depreciated straight-line over ten years to salvage the value of zero.
A) What is accounting break-even level of sales in terms of number of diamonds sold?
B) What is the NPV break-even level of sales assuming a tax rate of 35%, a 10 year project life, and a discount rate of 12 percent?
Problem 2: Operating Leverage
A project has fixed costs of $1000 per year, depreciation charges of $500 a year, a revenue of $6000 per year, and variable costs equal to two-thirds of revenues.
A) If sales increase by 5%, what will be the increase in pretax profits?
B) What is the degree of operating leverage of this project?
C) Confirm that the percentage change in profits equals DOL times the percentage change in sales.