An investment banker is analyzing two companies that specialize in the productio

Question

An investment banker is analyzing two companies that specialize in the production and sale of candied apples. Old-Fashion Apples uses a labor-intensive approach, and Mech-Apple uses a mechanized system. CVP income statements for t he two companies are shown below. 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. Determine which company's cost structure makes it more sensitive to changes in sales volume.

Explanation / Answer

Deg of operating lev= % change in ebit/ % change in sales

i.e DOL = contrb/cotrb-fixed costs

For OL Apples= 1.40
For Mech Apples= 2.00

Mech more sensitive to chnages as clear from above


New OL Apples sales=359280, Var costs also .9 *original var
fixed costs wont change

=> New Net income = .9 * contrb margin - fixed costs=48880
=> % change income OL Apples (sales down 10 %)= -14.00%

New net income Similarily for Mech Apples(sales down 10 %)=.9*234600-177800=33340
Change = 23460
=> % change in income= -41.30% for MECH APPLES


NOW Sales up by 5 % please do 1.05* margin - fixed costs as above to obtain answer.

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