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. Variable cost per unit (a) Sales revenue (8,000 units x $31.00) Variable cost (8,000 units x a) Contribution margin Fixed cost Net income Company Name Larson Benson $ 19.00 $ 9.50 $ 248,000 $ 248,000 (152,000) (76,000) $ 96,000 $ 172,000 (24,800) (100, 800) 71,200 71,200 $ Required a. Use the contribution margin approach to compute the operating leverage for each firm. b. If the economy expands in coming years, Larson and Benson will both enjoy a 12 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.) c. If the economy contracts in coming years, Larson and Benson will both suffer a 12 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.) Complete this by your answers in the tabs below. Required A Required B Required C Use the contribution margin approach to compute the operating leverage for each firm. (Round your answers to 2 decimal places.) Larson Benson Company Name Operating leverage

Answer 1

(A) Computation of operating leverage for both companies Larson and benson

Particulars	Larson	Benson
Sales revenue	$ 248000	$ 248000
Less : Variable cost	$ (152000)	$ (76000)
Contribution margin	$ 96000	$ 172000
Fixed cost	$ 24800	$ 100800
Net income	$ 71200	$ 71200
Operating leverage	1.35	2.42

Degree of Operating leverage = contribution / Net profit

Operating leverage for larson = 96000/71200 = 1.35

Operating leverage for Benson = 172000/71200 = 2.42

Computation of change in the net income for each firm (if 12 percent per year increase in sales)

Particulars	Larson ($)	Benson ($)
Variable cost per unit	19.00	9.50
Sales revenue	277760	277760
Variable cost	(170240)	(85120)
Contribution margin	107520	192640
Fixed income	(24800)	(100800)
Net income	82720	91840
Change in percentage	16.18	28.99

Notes -

Sales = [8000 units * 1.12] * 31 = 277760

Variable cost for Larson = [8000 units * 1.12] * 19

= $ 170240

Varible cost for Benson = [ 8000 units * 1.12] * 9.50

= $ 85120

Change in percentage of net income of Larson

= [(82720 - 71200 )÷ 71200]

= 11520 / 71200 = 16.18%

Change in percentage of net income of Benson

= [( 91840 - 71200) ÷ 71200]

= 20640/71200 = 28.99 %

Computation of change in the net income for each firm (if 12 percent per year decrease in sales)

Particulars	Larson ($)	Benson ($)
Variable cost per unit	19.00	9.50
Sales revenue	218240	218240
Variable cost	(133760)	(66880)
Contribution margin	84480	151360
Fixed cost	(24800)	(100800)
Net income	59680	50560
Change in percentage	-16.18%	-28.99%

Notes -

Sales revenue = (8000 * 0.88) * 31 = 218240

Variable cost of Larson = (8000 * 0.88) * 19 = 133760

Variable cost of Benson = (8000 * 0.88) * 9.50 = 66880

Change in percentage of net income of Larson

= (59680-71200) /71200

= (-11520) /71200 = -16.18%

Change in percentage of net income of Benson

= (50560 - 71200) / 71200

= (-20640) /71200 = -28.99%