Operating leverage in a single-product company

The case and its answers

Every question of this case, with its answer and why each other option is wrong.

A manufacturer sells 10,000 units annually at ₹500 each. Variable cost is ₹300 per unit and annual fixed operating cost is ₹15,00,000. There is no interest, tax, depreciation or inventory change in this simplified case. The analyst considers a downside scenario in which unit sales fall 20%, while selling price, variable cost per unit and total fixed cost remain unchanged. All units produced are sold and capacity is sufficient in both scenarios. The questions concern operating profit and break-even sales. They do not assume that all real-world costs would remain fixed under a larger or longer downturn.

All people, firms, prices and contract terms are fictional.

Ignore taxes and transaction costs unless the case explicitly includes them.

1. Q1What is contribution per unit?

   • A

     Option A. ₹50

     Why it is wrong: This is current operating profit per unit after fixed cost.

   • B

     Option B. ₹300

     Why it is wrong: This is variable cost per unit.

   • C

     Option C. ₹200 — Correct answer

   • D

     Option D. ₹500

     Why it is wrong: This is revenue per unit before variable cost.

   Answer: C. ₹500 − ₹300 = ₹200 per unit. Remember: Contribution first covers fixed operating costs.

   Hint, shown before you answer in practice mode: Subtract variable cost per unit from selling price.

   XV-S1-C04-Q1easynumerical

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2. Q2How many units are needed to break even on operating profit?

   • A

     Option A. 3,000 units

     Why it is wrong: This divides fixed cost by selling price instead of contribution.

   • B

     Option B. 10,000 units

     Why it is wrong: This is the current sales volume, which produces a profit.

   • C

     Option C. 5,000 units

     Why it is wrong: This divides fixed cost by variable cost.

   • D

     Option D. 7,500 units — Correct answer

   Answer: D. ₹15,00,000 ÷ ₹200 = 7,500 units. Remember: Break-even volume depends on contribution margin and fixed costs.

   Hint, shown before you answer in practice mode: Divide fixed operating cost by contribution per unit.

   XV-S1-C04-Q2mediumnumerical

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3. Q3What is current annual operating profit?

   • A

     Option A. ₹5,00,000 — Correct answer

   • B

     Option B. ₹15,00,000

     Why it is wrong: This is fixed cost, not profit.

   • C

     Option C. ₹20,00,000

     Why it is wrong: This is total contribution before fixed costs.

   • D

     Option D. ₹35,00,000

     Why it is wrong: This omits variable costs.

   Answer: A. 10,000 × ₹200 − ₹15,00,000 = ₹5,00,000. Remember: Operating profit is what remains after variable and fixed operating costs.

   Hint, shown before you answer in practice mode: Total contribution less fixed cost gives operating profit.

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4. Q4What operating profit remains after the 20% volume fall?

   • A

     Option A. −₹5,00,000

     Why it is wrong: This overstates the lost contribution.

   • B

     Option B. ₹1,00,000 — Correct answer

   • C

     Option C. ₹16,00,000

     Why it is wrong: This omits fixed costs from stressed contribution.

   • D

     Option D. ₹4,00,000

     Why it is wrong: This assumes profit falls by the same percentage as volume.

   Answer: B. 8,000 × ₹200 − ₹15,00,000 = ₹1,00,000. Profit falls 80%, showing the effect of operating leverage. Remember: Fixed costs can make profit change faster than sales volume.

   Hint, shown before you answer in practice mode: Use 8,000 units but retain the same total fixed cost.

   XV-S1-C04-Q4hardnumerical

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