Exercise 19-16 (Part Level Submission) An investment banker is analyzing two com
ID: 340849 • Letter: E
Question
Exercise 19-16 (Part Level Submission)
An investment banker is analyzing two companies that specialize in the production and sale of candied yams. Traditional Yams uses a labor-intensive approach, and Auto-Yams uses a mechanized system. CVP income statements for the two companies are shown below.
Traditional
Yams
Auto-Yams
Sales $408,000 $408,000
Variable costs 311,000 161,000
Contribution margin 97,000 247,000
Fixed costs 30,000 180,000
Net income $67,000 $67,000
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.
[Collapse question part]
(a1)
Calculate each company’s degree of operating leverage. (Round answers to 2 decimal places, e.g. 1.15.)
Degree of Operating Leverage
Traditional Yams
Auto-Yams
Determine the effect on each companys net income if sales decrease by 15% and if sales decrease by 10%. do not prepare income statements
Explanation / Answer
Req 1: CONTRIBUTION MARGIN INCOME STATEMENT TRADITIONAL AUTO YARN YARN Sales revenue 408000 408000 Less: Variable cost 311000 161000 Contribution margin 97000 247000 Less: Fixed cost 30000 180000 Net income 67000 67000 Degree of Operating leverage 1.45 3.69 (Contribution/ Net Operating income) Req 2: TRADITIONAL AUTO YARN YARN Degree of Operating leverage 1.45 3.69 Sales decrease by 15% 15% 15% Net Income decrease by 21.75% 55.35% Sales decrease by 10% 10% 10% Net income decrease by 14.50% 36.90%
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