CP

Business and Financial Risk 483

FIGURE 13-2 Illustration of Operating Leverage

Plan A Plan B

Price $2.00 $2.00

Variable costs $1.50 $1.00

Fixed costs $20,000 $60,000

Capital $200,000 $200,000

Tax rate 40% 40%

Plan A Plan B

Net Net

Pre-Tax Operating Pre-Tax Operating

Operating Profit after Operating Profit after

Units Dollar Operating Profits Taxes Operating Profits Taxes

Demand Probability Sold Sales Costs (EBIT) (NOPAT) ROIC Costs (EBIT) (NOPAT) ROIC

Terrible 0.05 0 $ 0 $ 20,000 ($20,000) ($12,000) 6.0% $ 60,000 ($ 60,000) ($36,000) 18.0%

Poor 0.20 40,000 80,000 80,000 0 0 0.0 100,000 (20,000) (12,000) 6.0

Normal 0.50 100,000 200,000 170,000 30,000 18,000 9.0 160,000 40,000 24,000 12.0

Good 0.20 160,000 320,000 260,000 60,000 36,000 18.0 220,000 100,000 60,000 30.0

Wonderful 0.05 200,000 400,000 320,000 80,000 48,000 24.0% 260,000 140,000 84,000 42.0

Expected value: 100,000 $200,000 $170,000 $30,000 $18,000 9.0% $160,000 $ 40,000 $24,000 12.0%

Standard deviation: $24,698 7.4% $ 49,396 14.8%

Coefficient of variation: 0.82 0.82 1.23 1.23

Notes:
a. Operating costs Variable costs
Fixed costs.
b. The federal-plus-state tax rate is 40 percent, so NOPAT EBIT(1 Tax rate) EBIT(0.6).
c. ROIC NOPAT/Capital.
d. The breakeven sales level for Plan B is not shown in the table, but it is 60,000 units or $120,000.
e. The expected values, standard deviations, and coefficients of variation were found using the procedures discussed in Chapter 3.

0 20406080100120

40

80

120

160

200

240

Sales (Thousands

of Units)

Revenues and Costs

(Thousands of Dollars)

Sales

Revenues

0 20406080100120

40

80

120

160

200

240

Sales (Thousands

of Units)

Revenues and Costs

(Thousands of Dollars)

Total Operating

Costs

Breakeven Point (EBIT = 0)

Fixed Costs

Fixed Costs

Plan A: Low Operating Leverage Plan B: High Operating Leverage

Positive

EBIT

Negative

EBIT Breakeven Point (EBIT = 0)

Positive

EBIT

Sales

Revenues

Negative

EBIT

Total Operating

Costs

Capital Structure Decisions 479