Question

Operating Leverage Income statements for two different companies in the same industry are as follows: Trimax, Inc. Quintex, Inc. $875,000 175,000 $700,000 630,000 $70,000 Sales $700,000 350,000 $350,000 280,000 $70,000 Less: Variable costs Contribution margin Less: Fixed costs Operating income Required: 1. Compute the degree of operating leverage for each company. Trimax Quintex 2. Compute the break-even point in dollars for each company Trimax, Inc. Quintex, Inc. Why is the break-even point for Quintex, Inc., higher? $700,000 350,000 $350,000 $875,000 175,000 $700,000 630,000 $70,000 Less: Variable costs Contribution margin Less: Fixed costs 280,000 $70,000 Operating income Required: 1. Compute the degree of operating leverage for each company Trimax Quintex 2. Compute the break-even point in dollars for each company. Quintex, Inc. Why is the break-even point for Quintex, Inc., higher? 3. Suppose that both companies experience a 50 percent increase in revenues. Compute the percentage change in profits for each company Trimax Quintex

Answer 1

1.

Degree of Operating Leverage = Contribution Margin / Operating Income

Trimax = $350,000 / $70,000

= 5

Therefore, degree of operating leverage of Trimax is 5.

Quintex = $700,000 / $70,000

= 10

Therefore, degree of operating leverage of Quintex is 10.

2.

Break-even point in dollars = Fixed Cost / Contribution Margin Ratio

Thus, first calculate the contribution ratio:

Contribution Margin Ratio = Contribution Margin / Sales * 100

Trimax = $350,000 / $700,000 * 100

= 50%

Quintex = $700,000 / $875,000 * 100

= 80%

Now, calculate the break-even point in dollars:

Break-even point in dollars = Fixed Cost / Contribution Margin Ratio

Trimax = $280,000 / 0.50

= $560,000

Therefore, break-even point in dollars of Trimax is $560,000.

Quintex = $630,000 / 0.80

= $787,500

Therefore, break-even point in dollars of Quintex is $787,500.

The reason for higher break-even point in dollars for Quintex is due to Higher Fixed Expenses.

3.

Particulars Sales (S700,000 50/100); (S875,000 50/100) Less: Variable Costs (S350,000*50/100); (S175,000*50/100) Contribution mar Less: Fixed Costs Trimax, Inc. (S) Quintex, Inc. (S) 1,312,500 262,500 1,050.000 630,000 420,000 1,050.000 525,000 525,000 280,000 245,000 ating Income % of Change in profits [($245,000-$70,000)/$70,000*1001; (S420000 S70,000)/S70,000 250% 500%