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
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Old-Fashion Apples
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Mech-Apple
|
|
Sales
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$400,000
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$400,000
|
|
Variable costs
|
320,000
|
160,000
|
|
Contribution margin
|
80,000
|
240,000
|
|
Fixed costs
|
20,000
|
180,000
|
|
Net income
|
$60,000
|
$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.