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ID: 2565558 • Letter: F
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The following is financial information relative to two companies in the same industry:
Category
Alpha
Omega
Sales
$10,000,000
$10,000,000
Variable Cost
5,000,000
2,000,000
Contribution Margin
5,000,000
8,000,000
Fixed Costs
3,000,000
6,000,000
Operating Income
$2,000,000
$2,000,000
Calculate the operating leverage for each firm.
If sales increased 10% for each firm, the variable cost per unit did not change, and the fixed costs did not change, what would be the change in operating income?
If sales decreased 20% for each firm, the variable cost per unit did not change, and the fixed costs did not change, what would be the change in operating income?
Discuss the nuances of operating leverage and its relation to risk.
Category
Alpha
Omega
Sales
$10,000,000
$10,000,000
Variable Cost
5,000,000
2,000,000
Contribution Margin
5,000,000
8,000,000
Fixed Costs
3,000,000
6,000,000
Operating Income
$2,000,000
$2,000,000
Explanation / Answer
Operating leverage = EBIT / Sales
ALPHA:
Operating leverage = $2000000 / $10000000
= 0.2
OMEGA
Operating leverage = $2000000 / $10000000
= 0.2
If sales increase 10%
Alpha Omega
Sales $11000000 $11000000
Variable cost ($5000000) ($2000000)
Contribution margin $6000000 $9000000
Fixed cost ($3000000) ($6000000)
Net operating income$3000000 $3000000
If sales increase 20%
Alpha Omega
Sales $12000000 $12000000
Variable cost ($5000000) ($2000000)
Contribution margin $7000000 $10000000
Fixed cost ($3000000) ($6000000)
Operating income $4000000 $4000000
Operating leverage is the combination of fixed costs and variable costs of a company. company has high fixed costs and low variable costs and it comes to high operating leverage, other than low fixed costs and high variable costs and it comes to low operating leverage.
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