HKOPEN is evaluating two different operating structures which are described below. The firm has annual interest expense of $250, common shares outstanding of 1,000, and a tax rate of 40%.
|
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Fixed costs
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Price per unit
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Variable cost per unit
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Operating structure1:
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$500
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$1
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$0.75
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Operating structure 2:
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$1,200
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$1
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$0.70
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Required:
(a) For each operating structure, calculate:
i. EBIT and EPS at 10,000, 20,000, and 30,000 units
ii. The degree of operating leverage (DOL) and degree of combined leverage (DCL) using 20,000 units as a base sales level
iii. The operating breakeven point in units.
(b) Which operating structure has greater operating leverage and business risk? Explain.
(c) If HKOPEN projects sales of 20,000 units, which operating structure is recommended? Discuss.