Answer:
The options are given below:
A. Firm X
B. Firm Y
C. Same variability of operating profits
D. It would depend on tax effect on taxable income
The correct option is B. Firm Y
Explanation:
This is because firm Y has a higher operating leverage than firm X.
<u>Operating Leverage</u> refers to a cost-accounting formula that measures the degree to which a firm can increase operating income by increasing revenue. Operating leverage actually boils down to the analysis of fixed costs and variable costs, and it is highest in companies that have a high fixed operating costs in comparison with variable operating costs. What this means is that this kind of company makes use of more fixed assets. On the other hand, operating leverage is lowest in companies that have a low fixed operating costs when compared with variable operating costs.
Companies with high operating leverage are capable of making more money from each additional sale if they do not have to incur more costs to produce more sales.
Therefore, from the scenario given above, we can conclude that firm Y has a higher operating leverage than firm X, because firm X has lower fixed costs than firm Y, and a higher variable cost than firm Y as well. Hence, firm Y has the potential to make more operating profits from its business activities.
We can find the increase in operating income for each $ 1,000 increase in revenue per month by finding the contribution margin ratio and the multiplying it with the increase operating income of $ 1,000 each.
The formula to find the contribution margin ratio is :-
Contribution margin ratio = Contribution margin per unit / Selling price per unit
= 12 / 20 = 60%
The increase in operating income = Contribution margin ratio * Revenue
= 60 % * 1,000
= $ 600
The calculations are shown below :-
Selling price per unit = $ 20
Variable cost per unit = $ 8
Contribution margin per unit = Selling price per unit - Variable cost per unit
= $ 20 - $ 8 = $ 12
