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Operating & Financial Leverage

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1. How can sales-mix changes impact a company's break-even point? And what other techniques can be used to effect BE?

2. What are the similarities and differences between operating and financial leverage? Could you provide some examples

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Please see response attached (also presented below), and supporting document for point of reference and examples. I hope this helps and take care.

RESPONSE:

1. How can sales-mix changes impact a company's break-even point?

The break-even point is the level of sales at which profit is zero. It can also be defined as the point where total sales revenue equals total expenses or as the point where total contribution margin equals total fixed expenses. Break-even analysis can be approached either by the equation method or by the contribution margin method. The two methods are logically equivalent (see page 3 of attachment "Cost-Volume-Profit Relationship" for these two methods).

Sales Mix. The term sales mix means the relative proportions in which a company's products are sold. Most companies have a number of products with differing contribution margins. Thus, changes in the sales mix can cause variations in a company's profits. As a result, the break-even point in a multi-product company is dependent on the mix in which the various products are sold.

Theoretically, however, the sales mix is constant. This assumption is invoked in order to use the simple break-even and target profit formulas in multi-product firms. If unit contribution margins are fairly uniform across products, violations of this assumption will not be important. However, if unit contribution margins differ a great deal, then changes in the sales mix can have a big impact on the overall contribution margin ratio and hence upon the results of CVP analysis and the break-even point. If a manager can predict how the sales mix will change, then a more refined CVP analysis ...

Solution Summary

This solution explains the impact of sales-mix changes on a company's break-even point (BE), some techniques used to effect BE, and the similarities and differences between operating and financial leverage, including examples. Supplemented with two supporting articles.

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Excessive, Operating and Financial Leverage

Q1. What does it mean when it is said that a company is excessively leveraged? What could be the effects of excessive leverage?

Q 2. Differentiate operating leverage, financial leverage, and the total leverage of the firm. Do these types of leverage complement one another? Why or why not?

Q3. (Weighted average cost of capital) In the spring of last year Tempe Steel learned that the firm would need to re-evaluate the company's weighted average cost of capital following a significant issue of debt. The firm now has financed 42% of its assets using debt and 58% using equity. Calculate the firm's weighted average cost of capital where the firm's borrowing rate on debt is 8.3%, it faces a 35% tax rate, and the common stockholders require a 20.6% rate of return.

Tempe Steels WACC is___% (Round to three decimal places.)

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