Question

Arnold Vimka is a venture capitalist facing two alternative investment opportunities. He intends to invest $1 million in a start-up firm. He is nervous, however, about future economic volatility. He asks you to analyze the following financial data for the past year’s operations of the two firms he is considering and give him some business advice.

Company Name Larson Benson Variable cost per unit (a) Sales revenue (8,400 units x $30.00) Variable cost (8,400 units x a) Contribution margin Fixed cost Net income $21.0010.50 $ 252,000 252,000 $ 75,600 163,800 $ 51,400 51,400 (176, 400) (88,200) (24,200) (112,400)

Required

1. Use the contribution margin approach to compute the operating leverage for each firm.

2. If the economy expands in coming years, Larson and Benson will both enjoy a 12 percent per year increase in sales, assuming that the selling price remains unchanged. Compute the change in net income for each firm in dollar amount and in percentage. (Note: Since the number of units increases, both revenue and variable cost will increase.)

3. If the economy contracts in coming years, Larson and Benson will both suffer a 12 percent decrease in sales volume, assuming that the selling price remains unchanged. Compute the change in net income for each firm in dollar amount and in percentage. (Note: Since the number of units increases, both revenue and variable cost will increase.)

Answer 1

Answer A)

Larson Company:

Operating Leverage = Contribution Margin / Net Income

Operating Leverage = $75,600 / $51,400

Operating Leverage = 1.47

Benson Company:

Operating Leverage = Contribution Margin / Net Income

Operating Leverage = $163,800 / $51,400

Operating Leverage = 3.19

Answer B) Company Name Larson Benson Variable cost per unit $21.00 $10.50 Sales revenue      2,82,240    2,82,240 Variable cost    -1,97,568      -98,784 Contribution margin         84,672    1,83,456 Fixed cost       -24,200 -1,12,400 Net income         60,472       71,056 Percentage change 17.65% 38.24%

Larson Company:

Sales = $252,000 * 1.12

Sales = $282,240

Variable Cost = $176,400 * 1.12

Variable Cost = $197,568

Percentage Change in sales = ($60,472 - $51,400) / $51,400

Percentage Change in sales = 17.65%

Benson Company:

Sales = $252,000 * 1.12

Sales = $282,240

Variable Cost = $88,200 * 1.12

Variable Cost = $98,784

Percentage Change in sales = ($71,056 - $51,400) / $51,400

Percentage Change in sales = 38.24%

Answer c)
Company Name
	Larson	Benson
Variable cost per unit	$21.00	$10.50
Sales revenue	2,21,760	2,21,760
Variable cost	-1,55,232	-77,616
Contribution margin	66,528	1,44,144
Fixed cost	-24,200	-1,12,400
Net income	42,328	31,744
Percentage change	-17.65%	-38.24%

Larson Company:

Sales = $252,000 * 0.88

Sales = $221,760

Variable Cost = $176,400 * 0.88

Variable Cost = $155,232

Percentage Change in sales = ($42,328 - $51,400) / $51,400

Percentage Change in sales = -17.65%

Benson Company:

Sales = $252,000 * 0.88

Sales = $221,760

Variable Cost = $88,200 * 0.88

Variable Cost = $77,616

Percentage Change in sales = ($31,744 - $51,400) / $51,400

Percentage Change in sales = -38.24%