Question

The following sales and cost data (in thousands) are for two companies in the transportation industry: Company A Percent of Amount Sales $140,000 100% 70,000 $ 70,000 50% 22,400 $ 47,600 Sales Variable costs Contribution margin Fixed costs Operating profit Company B Percent of Amount Sales $140,000 100% 42,000 $ 98,000 70% 43,400 $ 54,600 30 Required: 1-a. Calculate the degree of operating leverage (DOL) for each company. 1-b. If sales increase from the present level, which company benefits more? 2. Assume that sales rise 20% in the next year but that everything else remains constant. Calculate the percentage increase in profit for each company. Complete this question by entering your answers in the tabs below. Req 1A Reg 1B Reg 2 Calculate the degree of operating leverage (DOL) for each company. (Round your answers to 3 decimal places.) Company A Company B Degree of operating leverage

Answer 1

Transportation Industry Requirement 1a. DOL= Contribution margin = Operating profit A'S DOL = $70,000 - $47,600 = 1.47 B's DOL = $98,000 = $54,600 = 1.79 Requirement 1b. If sales increase, company B will benefit more. Company B has a higher proportion of fixed costs in relation to variable costs; therefore it has a higher operating leverage than does Company A. The degree of operating leverage (DOL) is a measure, at a specific level of sales, of how a percentage change in sales volume will affect profits. The higher the operating leverage, the more sensitive profits are to changes in sales volume. Requirement 2 Sales Variable cost Contribution Margin Fixed Costs Operating Profit Company A Company B Amount % of Sales Amount % of Sales 168000 100.00% 168000 100.00% 84000 50.00% 50400 30.00% 84000 50.00% 117600 70.00% 22400 43400 61600 74200 Company A's % change in operating profit = (new operating profit-prior operating profit)/prior operating profit ($61,600 - 47,600)/$47,600 = 29.41% Company B's % change in operating profit =(new operating profit -prior operating profit) prior operating profit ($74,200 - 54,600)/$54,600 = 35.89% The above results are what we expected. The DOL tells us the estimated % change in operating income for each percentage change in sales. A DOL of 1.47 implies that the change in operating income will be 1.47 times as large as the % change in sales volume. Therefore, as shown below, if sales increase by 20%, operating income for Company should increase by 29.41%, while the same 20% increase in sales resulted in a 35.89% change in operating income for Company B. A's % change in profits = DOLX % change in sales = 1.47 x 20% = 29.41% B's change in profits = DOL % change in sales = 1.79 % 20% = 35.89%