Problem 5 (Target Profit and Break-Even Analysis; Margin of Safety; CM Ratio)

1.

Fixed Cost
Break-even point (units) =
Contribution Margin per Unit
₱216,000.00
Break-even point (units) =
₱18.00
Break-even point (units) = 12,000

Fixed Cost
Break-even point (sales) =
1 - (Variable Cost/Sales)
₱216,000.00
Break-even point (sales) =
1 - (P180,000/P450,000)
₱216,000.00
Break-even point (sales) =
1 - 0.4
₱216,000.00
Break-even point (sales) =
0.60
Break-even point (sales) = ₱360,000.00

2. Contribution margin is equal to fixed cost therefore, the total contribution margin is
P216,000.
3.

Fixed cost + Target profit

Unit sales to attain target profit =
Contribution margin per unit
P216,000 + P90,000
Unit sales to attain target profit =
18
Unit sales to attain target profit = 17,000

Louis Company
Contribution Income Statement
Total
Sales (17,000 x P30) ₱510,000.00
Variable Expenses (17,000 x P12) (₱204,000.00)
Contribution Margin ₱306,000.00
Fixed Expenses (₱216,000.00)
Net operating income ₱90,000.00
 4.
Margin of Safety (pesos) = Total Sales - Break-even Sales
Margin of Safety (pesos) = P450,000- P360,000
Margin of Safety (pesos) = ₱90,000.00

Margin of safety (peso)

Margin of Safety (%) =
Total Sales
₱90,000.00
Margin of Safety (%) =
₱450,000.00
Margin of Safety (%) = 20%

5.

Unit Contribution Margin

CM Ratio =
Unit Selling Price
₱18.00
CM Ratio =
₱30.00
CM Ratio = 60%
Expected monthly net operating income = Increase in Sales per month x CM Ratio
Expected monthly net operating income = P50,000 x 60%
Expected monthly net operating income = ₱30,000.00

Problem 6 (Operating Leverage)

Required:

1. Prepare a contribution format income statement for the game last year and compute the
degree of operating leverage.

Galaxy Beyond, Inc.

Contribution Income Statement
Total Per Unit
Sales ₱3,000,000.00 ₱200.00
Variable Expenses ₱900,000.00 ₱60.00
Contribution
Margin ₱2,100,000.00 ₱140.00
Fixed Expenses ₱1,820,000.00
Net operating
income ₱280,000.00

Contribution Margin
Degree of operating leverage =
Net Operating Income
₱2,100,000.00
Degree of operating leverage =
₱280,000.00
 Degree of operating leverage = 7.5

2. Management is confident that the company can sell 18,000 games next year (an increase of
3,000 games, or 20%, over last year). Compute:

a. The expected percentage increase in net operating income for next year
degree of operating leverage x
Expected percentage increase = expected percentage
Expected percentage increase = 7.5 x 20%
Expected percentage increase = 1.5 or 150%

b. The expected total peso net operating income for next year
Last year operating income ₱280,000.00
Expected increase in net operating income next year
(150% x P280,000) ₱420,000.00
Total expected net operating income ₱700,000.00

Problem 10 (Degree of Leverage)

a.
Sales - Variable Cost
Degree of operating leverage =
EBIT
P1,200,000 - P600,000
Degree of operating leverage =
₱200,000.00
₱600,000.00
Degree of operating leverage =
₱200,000.00
Degree of operating leverage = 3

b.
EBIT
Degree of financial leverage =
EBIT - 1
₱200,000.00
Degree of financial leverage =
P200,000 - P50,000
₱200,000.00
Degree of financial leverage =
₱150,000.00
Degree of financial leverage = 1.33

c.
Q(P-VC)
Degree of combined leverage =
Q(P-VC) - FC - 1
20,000(P60 - P30)
Degree of combined leverage =
20,000(P60 - P30) - P400,000 - P50,000
 600,000
Degree of combined leverage =
150,000
Degree of combined leverage = 4

d.
Fixed Cost
Break-even point in units = Contribution Margin per
Unit
₱400,000.00
Break-even point in units =
₱30.00
Break-even point in units = 13,333

Problem 13 (Leverage and Sensitivity Analysis)

a. ROA = 10%, Value of assets = P12,000,000

EBIT = Assets x ROA

EBIT = P12,000,000 x 10%
EBIT = P1,200,000

Earnings after tax

Earnings per share =
Number of common shares issued

Return on Assets @ 10%

Current Plan D Plan E

EBIT ₱1,200,000.00 ₱1,200,000.00 ₱1,200,000.00
Less: Interest ₱600,000.00 ₱960,000.00 ₱300,000.00
EBT ₱600,000.00 ₱240,000.00 ₱900,000.00
Less: Taxes @45% ₱270,000.00 ₱108,000.00 ₱405,000.00
Earnings after tax ₱330,000.00 ₱132,000.00 ₱495,000.00
Common shares 750000.00 375000.00 1125000.00
EPS ₱0.44 ₱0.35 ₱0.44

Interest
Current: P6,000,000 debt x 10%
Plan D: P600,000 interest + (P3,000,000 debt x 12%)
Plan E: P6,000,000 - P3,000,000 debt x 10%

Common shares
Current: P6,000,000 common stock / P8 par value
Plan E: 750,000 + 375,000 shares
Effect of each Plan to EPS
Both the current plan and the Plan E have the same EPS of P0.44 and it is because the cost of debt is
equal to the operating return of asset of 10%. While Plan D has an EPS of P0.35 because there is an
increase of 12% in the cost of debt and resulted to an increase of financial risk of the company.

b. ROA = 5% and 15%, assets = P12,000,000

EBIT = Assets x ROA

EBIT = P12,000,000 x 5%
EBIT = P600,000

Return on Assets @ 5%

Current Plan D Plan E

EBIT ₱600,000.00 ₱600,000.00 ₱600,000.00
Less: Interest ₱600,000.00 ₱960,000.00 ₱300,000.00
EBT ₱0.00 -₱360,000.00 ₱300,000.00
Less: Taxes @45% -₱162,000.00 ₱135,000.00
Earnings after tax -₱198,000.00 ₱165,000.00
Common shares 750000.00 375000.00 1125000.00
EPS ₱0.00 -₱0.53 ₱0.15

EBIT = Assets x ROA

EBIT = P12,000,000 x 15%
EBIT = P1,800,000

Return on Assets @ 15%

Current Plan D Plan E

EBIT ₱1,800,000.00 ₱1,800,000.00 ₱1,800,000.00
Less: Interest ₱600,000.00 ₱960,000.00 ₱300,000.00
EBT ₱1,200,000.00 ₱840,000.00 ₱1,500,000.00
Less: Taxes @45% ₱540,000.00 ₱378,000.00 ₱675,000.00
Earnings after tax ₱660,000.00 ₱462,000.00 ₱825,000.00
Common shares 750000.00 375000.00 1125000.00
EPS ₱0.88 ₱1.23 ₱0.73

Based on the table, if the ROA is 5%, Plan E would be the favourable EPS while if the ROA increase to
15%, Plan D is the favourable EPS but it is still risky since the interest coverage is less than 2.0.
 c.

Return on Asset @10% with P12 as per share value

Current Plan D Plan E

EBIT ₱1,200,000.00 ₱1,200,000.00 ₱1,200,000.00
Less: Interest ₱600,000.00 ₱960,000.00 ₱300,000.00
EBT ₱600,000.00 ₱240,000.00 ₱900,000.00
Less: Taxes @45% ₱270,000.00 ₱108,000.00 ₱405,000.00
Earnings after tax ₱330,000.00 ₱132,000.00 ₱495,000.00
Common shares 750000.00 500000.00 1000000.00
EPS ₱0.44 ₱0.26 ₱0.50

Common Share
Plan D: 750,000 - (3,000,000/12) = 500,000 shares
Plan E: 750,000 + (3,000,000/12) = 1,000,000 shares

Plan E with an EPS of P0.50 is the most favourable as the price of common share increases because
in Plan D, some shares can be retireable which means that under Plan E, fewer shares needs to be
sold.