Introduction to Corporate Finance

11: Risk and Capital Budgeting

example

TABLE 11.1 FINANCIAL DATA FOR AUSTRAL CARBONLITE AND FIBERSPEED CORP.

Item Carbonlite Fiberspeed

Fixed cost per year $5 million $2 million

Variable cost per bike frame $400 $700

Sale price per bike frame $1,000 $1,000

Contribution margina per bike frame $600 $300

Last year’s sales volume 10,000 frames 10,000 frames

EBITb $1 million $1 million

a The contribution margin is the sale price per unit minus the variable cost per unit.

For Carbonlite: $1,000 – $400 = $600 per bike.

For Fiberspeed: $1,000 – $700 = $300 per bike.

b EBIT equals sales volume multiplied by the contribution margin minus fixed costs.

For Carbonlite: (10,000 × $600) – $5,000,000 = $1,000,000.

For Fiberspeed: (10,000 × $300) – $2,000,000 = $1,000,000.

FIGURE 11.1 OPERATING LEVERAGE FOR AUSTRAL CARBONLITE AND FIBERSPEED

The higher operating leverage of Carbonlite is reflected in its steeper slope, demonstrating that its EBIT is more responsive
to a given change in sales than is the EBIT of Fiberspeed. We assume in this figure that the responses of EBIT to sales are
linear (straight lines), but this need not always be the case.

Sales

EBIT

Carbonlite

Fiberspeed

0