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Following table shows information of company A and Company B. Firm A Firm B Sales Same...

Following table shows information of company A and Company B.

Firm A

Firm B

Sales

Same

Same

Contribution Margin

Lower

Higher

Margin of Safety

Higher

Lower

a. Which company should perform better if sales increase by 10% for both companies and why?

b. Which company should perform better if sales decrease by 10% for both companies and why?

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Answer #1

Solution a:

Firm B should perform better  if sales increase by 10% for both companies because firm B is having higher contribution margin ratio and increase in sale will result in higher net operating income.

Solution b:

Firm A should perform better if sales decreases by 10% of both companies as firm A is having higher margin of safety ratio. It means it is having lesser fixed cost than firm B. Therefore if sales decreases, it may still earn income as its Margin of safety is higher. On the other hand, firm B is having lower margin of safety, if sales decreases it may result in to loss or very less profits.

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