Question

Exercise 9-32 Degree of Operating Leverage (DOL) (LO 9-5] Tasty Kreme and Krispy Kake are both producers of baked goods, but each has followed a different production strategy. The differences in their strategies resulted in differences in their cost structure, as shown in the following table: Estimated sales in units Unit price Variable cost per unit Total fixed costs TastyKreme Krispy Kake 28,000 27,000 8 8 5 $ 42,000 $81,000 3 Required: 1. Compute the operating income and degree of operating leverage (DOL) for each company. (Round "Degree of operating leverage" to 1 decimal place.) 2. Assuming sales volume for each company will decline by 10% and that their cost structures will not change, compute the percentage and dollar amount of the change in operating income for each company. (Negative values should be indicated by a minus sign.) Tasty Kreme Krispy Kake 1. Operating income Degree of operating leverage Percentage change in operating income Dollar change in operating income

Answer 1

ANSWER:

(1)

For TastyKreme

operating income = [28000 x ($8 - $5)] - $42000

= $42000

For Krispy Kake

operating income = [27000 x ($8 - $3)] - $81000

= $54000

(1)

For TastyKreme

degree of operating leverage = contribution margin/operating income

= [28000 x ($8 - $5)]/42000

= 2

For Krispy Kake

degree of operating leverage = contribution margin/operating income

= [27000 x ($8 - $3)]/$54000

= 2.5

(2)

For TastyKreme

new sales volume = 28000 - 10%

= 25200

operating income = [25200 x ($8 - $5)] - $42000

= $33600

therefore,

dollar change in operating income = $42000 - $33600 = $8400

% change in operating income = $8400/$42000 = 20%

For Krispy Kake

new sales volume = 27000 - 10%

= 24300

operating income = [24300 x ($8 - $3)] - $81000

= $40500

therefore,

dollar change in operating income = $54000 - $40500 = $13500

% change in operating income = $13500/$54000 = 25%