Question

Healthy Foods Inc. sells 50-pound bags of grapes to the military for \(10 a bag. The fixed costs of this operation are \)80,000, while the variable costs of grapes are \(0.10 per pound.

d. If Healthy Foods has an annual interest expense of \)10,000, calculate the degree of financial leverage at both 20,000 and 25,000 bags.

Short answer

The financial leverage at 20,000 bags is 2 and at 25,000 bags is 1.29.

Step-by-step solution

Income statement at the sales volume of 20,000 bags and at 25,000 bags

Particulars	20,000 bags	25,000 bags
Sales	$200,000 (20,000 x $10)	$250,000 (25,000 x $10)
Less: variable cost	100,000 (20,000 x $5)	125,000 (25,000 x $5)
Contribution	$100,000	$125,000
Less: Fixed cost	80,000	80,000
EBIT	$20,000	$45,000
Less: Interest expenses	10,000	10,000
EBT	$10,000	$35,000

Financial leverage at 20,000 bags

$\begin{array}{rcl}\mathrm{Financial}\mathrm{leverage}& =& \frac{\mathrm{EBIT}}{\mathrm{EBT}}\\ & =& \frac{\$20,000}{\$10,000}\\ & =& 2\end{array}$

Financial leverage at 25,000 bags

$\begin{array}{rcl}\mathrm{Financial}\mathrm{leverage}& =& \frac{\mathrm{EBIT}}{\mathrm{EBT}}\\ & =& \frac{\$45,000}{\$35,000}\\ & =& 1.29\end{array}$