Question

Tasty Time Cafeteria operates cafeteria food services in public buildings in the Midwest. Tasty Time is contemplating a major change in its cost structure. Currently, all of their cafeteria lines are staffed with hourly wage employees who hand serve the food to customers. Benson Riggs, Tasty Time’s owner, is considering replacing the employees with an automated self-service system. However, before making the change, Benson would like to know the consequences of the change, since the volume of business varies significantly from location to location. Shown below are the CVP income statements for each alternative.

Personal Service System Automated Self-Service System

Sales $2,280,000 $2,280,000
Variable costs 1,710,000 1,140,000
Contribution margin $570,000 $1,140,000
Fixed costs 114,000 684,000
Net Income $456,000 $456,000

Required:
a. Determine the degree of operating leverage for each alternative.
b. Which alternative would produce the higher net income if sales increased by $228,000?

Answer 1

a. Personal Service System = 1.25 and Automated Self-Service System = 2.50

b. Automated Self-Service System will produce the higher net income.

Step-by-step explanation:

1. Degree of Operating Leverage (DOL)

Degree of Operating Leverage (DOL) shows the times Earnings Before Interest and Tax (EBIT) will change as a result of a change in sales contribution.

Degree of Operating Leverage (DOL) = Contribution ÷ Earnings Before Interest and Tax

Therefore,

Degree of Operating Leverage (DOL) for each service will be as follows :

Personal Service System = $570,000 ÷ $456,000

= 1.25

Automated Self-Service System = $1,140,000 ÷ $456,000

= 2.50

2. Effect on Net Income

If Sales increase by $228,000, that is a 10 % increase.

Which will have the following effect on Net Incomes of the proposed services :

Personal Service System = 10 % × 1.25 = 12.5 %

Automated Self-Service System = 10 % × 2.50 = 25 %

Conclusion

Automated Self-Service System will produce the higher net income.