Question

Company A is a manufacturer with sales of $3,500,000 and a 50% contribution margin. Its fixed costs equal $1,320,000. Company B is a consulting firm with service revenues of $3,600,000 and a 20% contribution margin. Its fixed costs equal $270,000. Compute the degree of operating leverage (DOL) for each company. Which company benefits more from a 20% increase in sales. Complete this question by entering your answers in the tabs below. DOL Company Benefits Compute the degree of operating leverage (DOL) for each company. Contribution Margin Income Statement Company A Company B

Answer 1

Answer:

Computation of Degree of operating leverage (DOL) for each company

Degree of operating leverage (DOL) = Contribution Margin / Operating Income

Contribution Margin Income Statement
Particulars	Company A	Company B
Sales	$3,500,000	$3,600,000
Contribution Margin %	50%	20%
Contribution Margin	$1,750,000	$720,000
Less: Fixed Costs	$1,320,000	$270,000
Operating Income	$430,000	$450,000

Degree of Operating Leverage
Choose:	Numerator	/	Denominator	=	Ratio
		/		=	Degree of Operating Leverage
Company A	$1,750,000	/	$430,000	=	4.07
Company B	$720,000	/	$450,000	=	1.6

Company Benefits:

Given that there is 20% increase in company sales

If there is an increase in sales the company with Higher Degree of operating leverage (DOL) will benefit more as there is higher change in operating income (Positive).

Hence in the given case Company A will benefit more as it is having Higher Degree of operating leverage (DOL) than Company B.

Revised Contribution Margin Income Statement
Particulars	Company A	Company B
Sales (Original Sales * 120%)	$4,200,000	$4,320,000
Contribution Margin %	50%	20%
Contribution Margin	$2,100,000	$864,000
Less: Fixed Costs	$1,320,000	$270,000
Operating Income	$780,000	$594,000

% change in Operating income of Company A = {($780,000 - $430,000) / $430,000} * 100

                                                                          = $350,000 / $430,000 * 100

                                                                           = 81.39% or 81.4%

% change in Operating income of Company B = {($594,000 - $450,000) / $450,000} * 100

                                                                          = $144,000 / $450,000 * 100

                                                                          = 32%