Question

1. The following table contains selected operating data for 2 competing firms in the same industry.

Matasia Company Ltd (Kshs)

Corner Baridi Company Ltd (Kshs)

Sales	25,000,000                    30,000,000
Fixed Costs Variable Costs	8,000,000                      15,000,000
	40% of Sales                 30% of Sales

Required

1. For both companies determine the Degree of Operating Leverage                    (4 marks)

Which company has a greater amount of business risk and why?        (2 mark

Answer 1

Degree of operating leverage :

a) Degree of operating leverage of Matasia Company Ltd (Kshs) :

  Sales revenue = 25000000

less variable cost    =(10000000)

( 40% of sale) 25000000*40%   

Contribution margin = 15000000

  less fixed cost =(8000000)

Operating income = 7000000

DOL = Contribution margin / operating income

= 15000000 / 7000000

= 2.14 times

b)Degree of operating leverage of Corner Baridi Company Ltd (Kshs)

  Sales revenue = 30000000

less variable cost    =(9000000)

( 30% of sale) 30000000*30%   

Contribution margin = 21000000

  less fixed cost =(15000000)

Operating income = 6000000

  

DOL = Contribution margin / operating income

= 21000000 / 6000000

= 3.5times

Degree of operating leverage of Matasia Company Ltd (Kshs) : = 2.14 times

Degree of operating leverage of Corner Baridi Company Ltd (Kshs)  = 3.5 times

here higher DOL IS Baridi company ltd 3.5 times.it means that the company's fixed cost exceed the variable cost. so the company can increase its sales.so it have higher risky too .since it implies that current profit margin are less secure moving into future