Once upon a time, there were two brothers (Barry and Larry) who dreamed about ow

Question

Once upon a time, there were two brothers (Barry and Larry) who dreamed about owning and operating companies in the same line of business. Barry believed in maintaining a very large, highly productive manual labor force. Larry, on the other hand, favored using a much smaller labor force and highly automated production processes instead. One brother's business was located in Madison, while the other brother's business was located in Austin. Here is information about each of the two businesses:

Results for the current year                          Madison               Austin

Sales    $ 2,000,000           $2,000,000

Contribution Margin                                 1,700,000               400,000

Net Income    150,000                  150,000

Required:

A. Of these two businesses, Madison or Austin, (1) which one has the higher level of variable cost and (2) which one has the higher level of fixed cost? Explain how you determined your answers.

B. Which brother probably owns the business in Madison? Which one probably owns the business in Austin? Explain how you determined your answers.

C. Compute the Breakeven Point in sales dollars for each of the two businesses.

D. Compute for each of the two businesses the total amount of sales (in dollars) that would be required to earn a net income of $100,000.

E. What is the current margin of safety for each of these two businesses.

F. Compute the degree of operating leverage for each of the two businesses.

G. Suppose that each of these two businesses had an opportunity to increase its current sales by 10%. Which business would experience a larger percentage change in net income as a result in that 10% increase in sales? Explain why and show computations to back up your answer.

Explanation / Answer

A. Madison Austin Sales 2000000 2000000 Contribution Margin 1700000 400000 Variable cost(Sales-Contribution Margin) 300000 1600000 1) So, Austin has the higher level of Variable Cost 2) Contribution Margin 1700000 400000 Net Income 150000 150000 Fixed Costs(Contribution Margin-Net Income) 1550000 250000 1) So, Madison has the higher level of Fixed Cost B. Barry believed in maintaining a very large, highly productive manual labor force Direct Labour cost is a variable cost that varies in direct proportion to no.of units sold and sales.Results of AUSTIN show very high variable costs- So, Barry owns Austin business. Larry, on the other hand, favored using a much smaller labor force and highly automated production processes instead.This involves huge fixed cost outlay. Madison results show high fixed costs. So, Larry owns Madison business. C. Madison Austin Sales 2000000 2000000 Contribution Margin 1700000 400000 Fixed Costs 1550000 250000 BEP in Sales $ Fixed costs/Contribution Margin Ratio Contribution Margin Ratio= Contribution/Sales Contribution Margin Ratio 1700000/2000000 400000/2000000 Verification of BEP 0.85 0.2 Sales 1823529 1250000 Less: V.C. 273529 1000000 So, BEP= 1550000/0.85 250000/0.2 Contn 1550000 250000 $ 1823529 1250000 Less: F.C. 1550000 250000 Profit 0 0 D.Total amount of sales (in dollars) that would be required to earn a net income of $100,000 Verification of BEP Madison Austin Madison Austin Fixed Costs 1550000 250000 Sales 1941176 1750000 Targeted Profit 100000 100000 Less: V.C. 291176 1400000 So, Target Contribution Reqd. 1650000 350000 Contn 1650000 350000 Less: F.C. 1550000 250000 Reqd. Sales In $ Target Contn/Contn. Margin Ratio Profit 100000 100000 1650000/0.85 350000/0.2 1941176 1750000 E. Current Sales $ 2000000 2000000 Current BEP In $ 1823529 1250000 Margin of Safety= Sales- BEP 176471 750000 F. Degree of operating leverage for each of the two businesses. DOL=Contribution Margin/Operating Income 1700000/150000 400000/150000 11.33 2.67 G. Suppose that each of these two businesses had an opportunity to increase its current sales by 10%. Business that would experience a larger percentage change in net income Madison Austin Sales 2200000 2200000 Less: V.C. 330000 1760000 Contn 1870000 440000 Less: F.C. 1550000 250000 Income 320000 190000 Original Income 150000 150000 % Change in Income (320000-150000)/150000 (190000-150000)/150000 113.33 26.67 Increase in Income % in   response to 10% Increase in sales is more pronounced with Madison Business as DOL is more and fixed costs are more. Ecen a smallchange in sales brings higher % of change in income

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