Question

Arnold Vimka is a venture capitalist facing two alternative investment opportunities. He intends to invest $1,000,000 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)	$	18.00			$	9.00
Sales revenue (8,100 units × $31.00)	$	251,100			$	251,100
Variable cost (8,100 units × a)		(145,800	)			(72,900	)
Contribution margin	$	105,300			$	178,200
Fixed cost		(25,000	)			(97,900	)
Net income	$	80,300			$	80,300

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 11 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 11 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 decreases, both total revenue and total variable cost will decrease.)

Answer 1

Larson Contribution Margin Net income Benson 105300 178200 80300 80300 Degree of Operating Leverage Degree of Operating Leverage 1.31 2.22 Larson Benson Sales are increase to 11% = 8100*1.11% =8991 Larson Benson Varaible cost Per Unit 18 Sales Revenue 278721 278721 Varaible cost -161838 -80919 Contibution Margin 116883 197802 Fixed cost -25000 -97900 Net income 91883 99902 Percentage Change 14.42% 24.41%

18 Sales are decrease to 11% = 8100*0.89% =7209 Larson Benson Varaible cost Per Unit Sales Revenue 223479223479 Varaible cost -129762 -64881 Contibution Margin 93717 158598 Fixed cost -25000 -97900 Net income 68717 60698 Percentage Change -14.42% -24.41%