Question

Atech has fixed costs of $11.2 million and profits of $4 million. Its competitor, ZTech, is roughly the same size and this year earned the same profits, $4 million. However, ZTech operates with fixed costs of $1.56 million and lower variable costs. a. Calculate the operating leverage for each firm. b. Which firm has higher operating leverage? c. Which firm will likely have higher profits if the economy strengthens?

Answer 1

1. The operating leverage for Atech and ZTech is 3.8 and 1.39 respectively.

2. The Atech firm has higher operating leverage.

3. The Atech has will likely to have higher profits if the economy strengthens as it contain high operating leverage.

Step-by-step explanation:

a. The formula to compute operating leverage is equals to

= Contribution ÷ Net income

Since we don't know the value of contribution. But the contribution is a sum of net income and fixed cost.

So ,

For Atech, the contribution will be

= $11.2 million + $4 million

= $15.2 million

And, For Ztech, the contribution will be

= $1.56 million + $4 million

= $5.56 million

Now,

The contribution margin for Atech is

= $15.2 million ÷ $4 million

= 3.8

And, The contribution margin for Ztech is

= $5.56 million ÷ $4 million

= 1.39

Hence, the operating leverage for Atech and ZTech is 3.8 and 1.39 respectively.

2. After calculating the operating leverage, we get to know that Atech has higher operating leverage than Ztech.

Thus, Atech firm has higher operating leverage.

3. By calculating the operating leverage, the Atech has will likely to have higher profits if the economy strengthens as it contain high operating leverage.