Question

An investment banker is analyzing two companies that specialize in the production and sale of candied yams. Traditional Yams uses a labor-intensive approach, and Auto-Yams uses a mechanized system. CVP income statements for the two companies are shown below. Traditional Yams Auto-Yams Sales $397,000 $397,000 Variable costs 329,000 162,000 Contribution margin 68,000 235,000 Fixed costs 18,000 185,000 Net income $50,000 $50,000 The investment banker is interested in acquiring one of these companies. However, she is concerned about the impact that each company’s cost structure might have on its profitability. Calculate each company’s degree of operating leverage. (Round answers to 2 decimal places, e.g. 1.15.) Degree of Operating Leverage Traditional Yams Auto-Yams LINK TO TEXT Determine the effect on each company’s net income if sales decrease by 20% and if sales increase by 5%. Do not prepare income statements. (Round answers to 2 decimal places, e.g. 10.52. If % change is negative, enter amount with either a negative sign or parenthesis, e.g. -10.52 or (10.52).) % Change in Net Income Sales decrease by 20% Traditional Yams % Auto-Yams % Sales increase by 5% Traditional Yams % Auto-Yams %

Answer 1

Degree of operating leverage = Contribution margin/Net income

	Traditional Yams	Auto-Yams
Contribution margin (a)	68000	235000
Net income (b)	50000	50000
Degree of operating leverage (a)/(b)	1.36	4.70

Sales decrease by 20%:

	Traditional Yams	Auto-Yams
Change in net income	-27.20%	-94.00%
	(1.36 x 20%)	(4.70% x 20%)

Sales increase by 5%:

	Traditional Yams	Auto-Yams
Change in net income	6.80%	23.50%
	(1.36 x 5%)	(4.70% x 5%)