Two brothers (Baylor and Lamar) dreamt about owning and operating companies in the same line of business. Baylor believed in maintaining a very large, highly efficient manual labor force; Lamar, on the other hand, favored automated-production processes. One business was located in Omaha and the other was located in Tulsa. Recent data follow.?OmahaTulsaSales$2,000,000$2,000,000Contribution margin1,500,000450,000Income150,000150,000Required: A. Which of the two businesses, Omaha or Tulsa, has the higher level of (1) variable cost and (2) higher level of fixed cost? Explain how you determined your answer.B. Determine the probable owner of the firm located in (1) Omaha and (2) Tulsa. Briefly explain your logic.C. Compute the operating leverage factor for Omaha and Tulsa.D. Suppose that

Question

both Omaha and Tulsa had the opportunity to increase sales by 10%. Which of the two locations would experience a larger percentage change in net income? Why?

What will be an ideal response?

Answer 1

A. Given that both locations have identical sales, Tulsa has a higher level of variable cost ($1,550,000 vs. $500,000) as indicated by a smaller contribution margin. Omaha, in contrast, has a higher amount of fixed cost ($1,350,000 vs. $300,000) because of the larger contribution margin and an income equal to that of Tulsa.
B. Operations with sizable labor forces have high variable costs; conversely, automated facilities give rise to high fixed costs (e.g., depreciation, lease payments, maintenance). Thus, Baylor's philosophy is most closely associated with the Tulsa facility, and Lamar's seems consistent with the cost structure in Omaha.
C. Omaha: $1,500,000 ÷ $150,000 = 10.0
Tulsa: $450,000 ÷ $150,000 = 3.0
D. Omaha would experience a larger percentage change in net income because it is more highly leveraged than Tulsa. Mathematically, the percentage change in income can be computed by multiplying the operating leverage factor by the percentage change in sales revenue.