Accounting: What the Numbers Mean 9th Edition by Wayne W McManus, Daniel F Viele, David H Marshall

Exercise 95

Understanding the effects of operating leverage HighTech, Inc., and OldTime

Co. compete within the same industry and had the following operating results in 2010:

	HighTech, Inc.	OldTime Co.
Sales	$2,100,000	$2,100,000
Variable expenses	420,000	1,260,000
Contribution margin	$1,680,000	$ 840,000
Fixed expenses	1,470,000	630,000
Operating income	$ 210,000	$ 210,000

Required:

a.Calculate the break-even point for each firm in terms of revenue.

---

b. What observations can you draw by examining the break-even point of each firm given that they earned an equal amount of operating income on identical sales volumes in 2010?

---

c. Calculate the amount of operating income (or loss) that you would expect each firm to report in 2011 if sales were to

1. Increase by 20%.

2. Decrease by 20%.

---

d. Using the amounts computed in requirement c, calculate the increase or decrease in the amount of operating income expected in 2011 from the amount reported in 2010.

---

e. Explain why an equal percentage increase (or decrease) in sales for each firm would have such differing effects on operating income.

---

f. Calculate the ratio of contribution margin to operating income for each firm in 2010. (Hint: Divide contribution margin by operating income.)

---

g. Multiply the expected increase in sales of 20% for 2011 by the ratio of contribution margin to operating income for 2010 computed in requirement f for each firm. (Hint: Multiply your answer in requirement f by 0.2.)

---

h. Multiply your answer in requirement g by the operating income of $210,000 reported in 2010 for each firm.

---

i. Compare your answer in requirement h with your answer in requirement d. What conclusions can you draw about the effects of operating leverage from the steps you performed in requirements f, g, and h?

Step 1 of 11

a)

Breakeven point: It is the point where the company is in the condition of neither profit nor the loss.

The breakeven revenue of both the companies can be calculated suing the following formula:

Breakeven revenue of H Tech Inc.

Substitute

For Fixed costs as $1,470,000, variable costs as $420,000 and Sales as $2,100,000

Thus the breakeven revenue for H Tech Inc. is

Breakeven revenue of O Time Co.

Substitute

For Fixed costs as $630,000, variable costs as $1,260,000 and Sales as $2,100,000

Thus the breakeven revenue for H Tech Inc. is .