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Question - An investment banker is analyzing two companies that specialize in the production and sale of candied apples. Old-Fashion Apples uses a labor-intensive approach, and Mech-Apple uses a mechanized system. CVP income statements for the two companies are shown below
Old-Fashion Apples
Mech-Apple
Sales
$400,000
Variable costs
320,000
160,000
Contribution margin
80,000
240,000
Fixed costs
20,000
180,000
Net income
$60,000
The investment banker is interested in acquiring one of these companies. However, she is concerned about the impact that each company's cost structure might have on its profitability.
Instructions -
(a) Calculate each company's degree of operating leverage. Determine which company's cost structure makes it more sensitive to changes in sales volume.
(b) Determine the effect on each company's net income if sales decrease by 10% and if sales increase by 5%. Do not prepare income statements.
(c) Which company should the investment banker acquire? Discuss.
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