Question

Company A is a manufacturer with current sales of $3,700,000 and a 60% contribution margin. Its fixed costs equal $1,810,000. Company B is a consulting firm with current service revenues of $3,800,000 and a 20% contribution margin. Its fixed costs equal $330,000.Compute the degree of operating leverage (DOL) for each company.Identify which company benefits more from a 20% increase in sales.Company ACompany B

Answer 1

Answer:

Company A 5.41

Company B 1.76

Company A benefits more from a 20% increase in sales.

Explanation:

The computation of the degree of operating leverage is shown below:-

Particulars            Company A           Company B

Sales                       $3,700,000          $3,800,000

Less:

Variable cost          $1,480,000             $3,040,000

                          ($3,700,000 × 40%)    ($3,800,000 × 80%)

Contribution

margin                  $2,220,000             $760,000

                      ($3,700,000 × 60%)     ($3,800,000 × 80%)

Less:

Fixed cost             $1,810,000              $330,000

Pretax income       $410,000                $430,000

After this we need to go further so that we can find out the degree of operating leverage For both company

For Company A

= Contribution margin ÷ Pretax income

= $2,220,000 ÷ $410,000

= 5.41

For company B

= Contribution margin ÷ Pretax income

= $760,000 ÷ $430,000

= 1.76

So, from the above calculation we can see that Company A is higher than Company B.