Butwal Manufacturing Company (BMC) produces and sells tea kettles. BMC sells its kettles at Rs 60 per kettle. The variables costs are Rs 40 per kettle. Fixed costs are Rs 200,000. a. What is the…

a. Break-even point

The break-even point is the level of sales where total revenue equals total cost, resulting in zero profit. It can be calculated using the formula:

$$\text{Break-even point (units)}=\frac{\text{Fixed Costs}}{\text{Selling Price per Unit}-\text{Variable Cost per Unit}}$$

Given:

• Selling price per kettle = Rs 60
• Variable cost per kettle = Rs 40
• Fixed costs = Rs 200,000

$$\text{Break-even point (units)}=\frac{200,000}{60-40}=\frac{200,000}{20}=10,000\text{ kettles}$$

Break-even point = 10,000 kettles

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b. Degree of Operating Leverage (DOL)

The degree of operating leverage measures the sensitivity of operating income to changes in sales. It is calculated as:

$$\text{DOL}=\frac{\text{Contribution Margin}}{\text{Operating Income}}$$

At sales of 15,000 kettles:

• Total revenue = 15,000 × Rs 60 = Rs 900,000
• Total variable cost = 15,000 × Rs 40 = Rs 600,000
• Contribution margin = Total revenue - Total variable cost = Rs 900,000 - Rs 600,000 = Rs 300,000
• Operating income = Contribution margin - Fixed costs = Rs 300,000 - Rs 200,000 = Rs 100,000

$$\text{DOL}=\frac{300,000}{100,000}=3$$

Degree of Operating Leverage = 3

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c. Degree of Financial Leverage (DFL)

The degree of financial leverage measures the sensitivity of net income to changes in operating income. It is calculated as:

$$\text{DFL}=\frac{\text{Earnings Before Interest and Tax (EBIT)}}{\text{Earnings Before Tax (EBT)}}$$

Given:

• Annual interest = Rs 10,000
• EBIT = Operating income = Rs 100,000 (from part b)
• EBT = EBIT - Interest = Rs 100,000 - Rs 10,000 = Rs 90,000

$$\text{DFL}=\frac{100,000}{90,000}=1.11$$

Degree of Financial Leverage = 1.11