Reference no: EM13505625

Understanding the Effects of Operating Leverage. This provides an illustration of CVP analysis.

HighTech, Inc., and OldTime Co. complete within the same industry and had the following operating results in 2010:

                                                                        HighTech,                              OldTime

                                                                              Inc.                                         Co.

Sales ..........................................       $2,100,000                           $2,100,000

Variable expenses ...........................            420,000                             1,260,000

Contribution margin ........................       $1,680,000                           $   840,000

Fixed expenses ..............................         1,470,000                                630,000

Operating income ...........................       $   210,000                                210,000                                                                      

Required:

a. Calculate the break-even point for each firm in terms of revenue.

b. What observations can you draw by examining the break-even point of each firm given that they earned an equal amount of operating income on identical sales volumes in 2010?

c.  Calculate the amount of operating income (or loss) that you would expect each firm to report in 2011 if sales were to

1.  Increase by 20%.

2.  Decrease by 20%.

d. Using the amounts computed in requirement c, calculate the increase or decrease in the amount of operating income expected in 2011 from the amount reported in 2010.

e. Explain why an equal percentage increase (or decrease) in sales for each firm would have such differing effects on operating income.

f. Calculate the ratio of contribution margin to operating income for each firm in 2010. (Hint: Divide contribution margin by operating income.)

g. Multiply the expected increase in sales of 20% for 2011 by the ratio of contribution margin to operating income for 2010 computed in requirement f for each firm. (Hint: Multiply your answer in requirement f by 0.2.)

h. Multiply your answer in requirement g by the operating income of $210,000 reported in 2010 for each firm.

i.  Compare your answer in requirement h with your answer in requirement d.

What conclusions can you draw about the effects of operating leverage from the steps you performed in requirements f, g, and h?