Question

Marina Manufacturing is considering buying new equipment for its factory. The new equipment will reduce variable labor costs but increase depreciation expense. Contribution margin is expected to increase from $250,000 to $300,000. Net income is expected to remain the same at $100,000. Compute the degree of operating leverage before and after the purchase of the new equipment and interpret your results.

Answer 1

Answer:

2.50 and 3

Explanation:

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

Degree of operating leverage = Contribution margin ÷ Net income

Before the purchase, it is

= $250,000 ÷ $100,000

= 2.5

And, after the purchase, it is

= $300,000 ÷ $100,000

= 3

So due to purchase of the new equipment the earning would be dropped by 1.2 times by dividing the 3 by 2.5 and there is a balance in increase and decrease in sales