If two companies have the same total sales and total expenses and make the same product, the volatility of net income with changes in sales will tend to be greater in the company with a higher proportion of fixed expenses in its cost structure.

Question

Quizplus · Accepted Answer

When a company has a higher proportion of fixed expenses in its cost structure, the net income will be more sensitive to changes in sales. This is because the fixed expenses must be paid regardless of sales volume, and any decrease in sales will lead to a larger proportion of fixed expenses being incurred, resulting in a greater decrease in net income. Therefore, the volatility of net income with changes in sales will be greater in the company with a higher proportion of fixed expenses.

If Two Companies Have the Same Total Sales and Total