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Break-Even Sales, Operating Leverage, Change in Income Income statements for two different companies in the same industry are as follows: Duncan Macduff Sales $375,000 $375,000 Total variable cost 300,000 150,000 Contribution margin $75,000 $225,000 Total fixed cost 50,000 200,000 Operating income $25,000 $25,000 Required: 1. Compute the degree of operating leverage for each company. Duncan Macduff 2. Conceptual Connection: Compute the break-even point in dollars for each company. Round to the nearest dollar. Duncan $ Macduff $ 3. Conceptual Connection: Suppose that both companies experience a 30% increase in revenues. Compute the percentage change in profits for each company. Duncan % Macduff %

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Answer:

Required: 1. Compute the degree of operating leverage

Duncan (DOL) = 3.00

Macduff (DOL) =  9.00

Required: 2. Compute the break-even point in dollars

Duncun Break - Even Point (dollars) = $250,000

Duncun Break - Even Point (dollars) =  $333,333

Required: 3. Compute the percentage change in profits

Both firms will experience a 4.5% change in Profit

Explanation:

Degree of Operating Leverage (DOL)  is the variation of Sales and Costs due to the Cost Structure of the Company.

Degree of Operating Leverage (DOL) = Sales - Variable Costs / (Sales - Variable Costs - Fixed Costs)

Duncan (DOL) = ($375,000 - $300,000) / ($375,000 - $300,000 - $50,000)

                        = 3.00

Macduff (DOL) = ($375,000 - $150,000) / ($375,000 - $150,000 - $200,000)

                        = 9.00

Break - even Point is the level of Activity where a company neither makes a profit nor a loss

Break - Even Point (dollars) = Fixed Costs / Contribution Margin Ratio

Duncun Break - Even Point (dollars) = $50,000 / ($75,000/$375,000)

                                                           = $250,000

Duncun Break - Even Point (dollars) = $200,000 / ($225,000/$375,000)

                                                           = $333,333

A 30% increase in revenues results in the following

Duncan :

Revenue                        $487,500

Less Variable Costs    ($300,000)

Less Fixed Costs           ($50,000)

Profit                               $137,500

Change in Profit = 4.5%

Macduff :

Revenue                        $487,500

Less Variable Costs    ($150,000)

Less Fixed Costs        ($200,000)

Profit                              $137,500

Change in Profit = 4.5%

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