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Question - An investment banker is analyzing two companies that specialize in the production and sale of candied apples. Old-Fashioned Apples uses a labour-intensive approach, and Mech-Apple uses a mechanized system. Variable costing income statements for the two companies are shown below:
Old-Fashioned Apples
Mech-Apple
Sales
$510,000
Variable costs
255,000
102,000
Contribution margin
408,000
Fixed costs
205,000
358,000
Operating income
$50,000
The investment banker wants to acquire one of these companies. However, she is concerned about the impact that each company's cost structure might have on its profitability.
Required -
(a) Calculate each company's degree of operating leverage.
(b) Determine which company's cost structure makes it more sensitive to changes in its sales volume. Present your answer in terms of the contribution margin ratio.
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