Operating leverage. Cover Rugs is holding a 2-week carpet sale at Josh’s Club, a local warehouse store. Cover Rugs plans to sell carpets for $950 each. The company will purchase the carpets from a local distributor for $760 each, with the privilege of returning any unsold units for a full refund. Josh’s Club has offered Cover Rugs two payment alternatives for the use of space. ■ Option 1: A fixed payment of $7,410 for the sale period ■ Option 2: 10% of total revenues earned during the sale period Assume Cover Rugs will incur no other costs. 1. Calculate the breakeven point in units for (a) Option 1 and (b) Option 2. 2. At what level of revenues will Cover Rugs earn the same operating income under either option? a. For what range of unit sales will Cover Rugs prefer Option 1? b. For what range of unit sales will Cover Rugs prefer Option 2? 3. Calculate the degree of operating leverage at sales of 65 units for the two rental options.
3-30 Operating leverage. Cover Rugs is holding a 2-week carpet sale at Josh’s Club, a local warehouse
store. Cover Rugs plans to sell carpets for $950 each. The company will purchase the carpets from a local
distributor for $760 each, with the privilege of returning any unsold units for a full refund. Josh’s Club has
offered Cover Rugs two payment alternatives for the use of space.
■ Option 1: A fixed payment of $7,410 for the sale period
■ Option 2: 10% of total revenues earned during the sale period
Assume Cover Rugs will incur no other costs.
1. Calculate the breakeven point in units for (a) Option 1 and (b) Option 2.
2. At what level of revenues will Cover Rugs earn the same operating income under either option?
a. For what range of unit sales will Cover Rugs prefer Option 1?
b. For what range of unit sales will Cover Rugs prefer Option 2?
3. Calculate the degree of operating leverage at sales of 65 units for the two rental options.
4. Briefly explain and interpret your answer to requirement 3.
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