Question

United Snack Company sells 50-pound bags of peanuts to university dormitories for \(20 a bag. The fixed costs of this operation are \)176,250, while the variable costs of peanuts are \(0.15 per pound.

d. If United Snack Company has an annual interest expense of \)15,000, calculate

the degree of financial leverage at both 19,000 and 24,000 bags.

Short answer

The financial leverage at 19,000 bags is 1.32 and at 24,000 bags is 1.14.

Step-by-step solution

Income statement at the sales volume of 19,000 bags and at 24,000 bags

Particulars	19,000 bags	24,000 bags
Sales	$380,000 (19,000 x $20)	$480,000 (24,000 x $20)
Less: variable cost	142,500 (19,000 x $7.50)	180,000 (24,000 x $7.5)
Contribution	$237,500	$300,000
Less: Fixed cost	176,250	176,250
EBIT	61,250	123,750
Less: Interest	15,000	15,000
EBT	$46,250	$108,750

Financial leverage at 19,000 bags

$\begin{array}{rcl}\mathrm{Financial}\mathrm{leverage}& =& \frac{\mathrm{EBIT}}{\mathrm{EBT}}\\ & =& \frac{\$61,250}{\$46,250}\\ & =& 1.32\end{array}$

Financial leverage at 24,000 bags

$\begin{array}{rcl}\mathrm{Financial}\mathrm{leverage}& =& \frac{\mathrm{EBIT}}{\mathrm{EBT}}\\ & =& \frac{\$123,750}{\$108,750}\\ & =& 1.14\end{array}$