Contribution margin income statements for two competing companies are provided below: Yin Company Yang CompanyRevenue $750,000 $750,000 Less variable costs 300,000 525,000 Contribution margin $450,000 $225,000 Less fixed costs 405,000 180,000 Net income $45,000 $45,000 Required: (1) Show each company's cost structure by inserting the percentage of the company's revenue represented by each item on the contribution income statement.(2) Compute each company's magnitude of operating leverage.(3) Using the operating leverage measures computed in requirement 2, determine the increase in each company's net income (percentage and amount) if each company experiences a 10 percent increase in sales.(4) Assume that sales are
expected to continue to increase for the foreseeable future, which company probably has more desirable cost structure? Why?
What will be an ideal response?
Answers will vary
1)
| Yin Company | Yang Company | ||||||||||
| Revenue | $ | 750,000 | 100 | % | $ | 750,000 | 100 | % | |||
| Less variable costs | 300,000 | 40 | % | $ | 525,000 | 70 | % | ||||
| Contribution margin | $ | 450,000 | 60 | % | $ | 225,000 | 30 | % | |||
| Less fixed costs | 405,000 | 54 | % | $ | 180,000 | 24 | % | ||||
| Net income | $ | 45,000 | 6 | % | $ | 45,000 | 6 | % | |||
2) Magnitude of operating leverage:
Yin Company = $450,000 contribution margin ÷ $45,000 net income = 10
Yang Company = $225,000 contribution margin ÷ $45,000 net income = 5
3) Expected profits when sales increase by 10%:
Yin Company: 10% × 10 magnitude of operating leverage = 100%
If sales increase by 10%, net income should increase to $90,000
Yang Company: 10% × 5 magnitude of operating leverage = 50%
If sales increase by 10%, net income should increase to $67,500
4) Cost structures: Assuming sales continue to increase, Yin Company will fare better than Yang Company because its contribution margin ratio is higher (60% vs. 30%) and its operating leverage is higher. This means that as sales increase, Yin Company's net income will increase more rapidly than Yang Company's.
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