Question

Russell Preston delivers parts for several local auto parts stores. He charges clients $0.85 per mile driven. Russell has determined that if he drives 3,000 miles in a month, his average operating cost is $0.75 per mile. If he drives 5,000 miles in a month, his average operating cost is $0.55 per mile. Russell has used the high-low method to determine that his monthly cost equation is total cost = $1,320 + $0.25 per mile. Required: 1. Determine how many miles Russell needs to drive to break even. 2. Assume Russell drove 2.600 miles last month. Without making any additional calculations, determine whether he earned a profit or a loss last month. 3. Determine how many miles Russell must drive to earn $1,500 in profit. 4-a. Prepare a contribution margin income statement assuming Russell drove 2,600 miles last month. 4-b. Use the information provided in Req 4a to calculate Russell's degree of operating leverage.

Answer 1

1) Break even = Fixed cost/Contribution margin per unit = 1320/(0.85-0.25) = 2200 Units

2) Break even unit is 2200 units so if company produced 2600 Units then it would be profit

3) Required unit = (1320+1500)/0.60 = 4700 Units

4a) Contribution margin income statement

Sales (2600*.85)	2210
Variable cost (2600*.25)	650
Contribution margin	1560
Fixed cost	1320
Net income (loss)	240

4b) Degree of operating leverage = Contribution margin/Net income = 1560/240 = 6.5