Question

Problem IV Assessing the magnitude of operating lever The following income statement is provided for Vargas, Inc. 10 points Sales revenue (2.500 units x 560 per unit) Cost of goods sold (variable: 2.500 units x 520 per unit) Cost of goods sold (fixed) Gross margin Administrative salaries Depreciation Supplies (2,500 units x 54 per unit) Net income $ 150.000 (50,000) (8,000 ) 92,000 (42,000) (10,000) (10.000 S 30.000 a) What is this company's magnitude of operating leveraget b) Use the measure of operating leverage to determine the amount of net income the company will earn if sales increase by 15%.

Answer 1

Solution a:

Contribution margin = Sales - Variable costs = $150,000 - ($50,000 + $10,000) = $90,000

Operating leverage = Contribution margin / Net operating income = $90,000 / $30,000 = 3

Solution b:

If sales increases by 15% then net income will increase by = % increase in sales * Operating leverage = 15% * 3 = 45%

Amount of net income company will earn = $30,000 * 145% = $43,500