Question

The CVP income statements shown below are available for Armstrong Company and Contador Company. Contador Co. Sales Variable costs Contribution margin Fixed costs Net income Armstrong Co. $500,000 240,000 260,000 160,000 $100,000 $500,000 50,000 450,000 350,000 $100,000 Degree of operating leverage for each company is as follows: Degree of Operating Leverage 2.6 4.5 Armstrong Contador Assuming that sales revenue increases by 10%, the variable costing income statement for each company is as follows: Sales Revenue Variable Costs Contribution Margin Fixed Costs Net Income Armstrong Company Contador Company $550,000 $550,000 264,000 55,000 286,000 495,000 160,000 350,000 $126,000 $145,000 Discuss the differences in operating leverage for the two companies. LINK TO TEXT Discuss how the cost structure of these two companies affects their operating leverage and profitability.

Answer 1

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Part a		Armstrong Co	Contador Co
Contribution	a	$             260,000	$          450,000
Net Income	b	$             100,000	$          100,000
Degree of operating leavarage	a/b	2.60	4.50
Part b
		Armstrong Co	Contador Co
Sales	Increase by 10%	$             550,000	$          550,000
Variable costs	Increase by 10%	$             264,000	$            55,000
Contribution margin		$             286,000	$          495,000
Fixed costs	Same	$             160,000	$          350,000
Net income		$             126,000	$          145,000
Part c
Both the company has increase of $50,000 in sale.
However, due to higher Degree of operating leavarage, Contador has higher increase
in NET INCOME i.e. $45,000 than $26,000 (increase in Armstrong net income).
This is because of higher degree of operating leavearage.