Question

Company A is a manufacturer with sales of $3,300,000 and a 60% contribution margin. Its fixed costs equal $1,450,000. Company B is a consulting firm with service revenues of $3,200,000 and a 30% contribution margin. Its fixed costs equal $460,000. Compute the degree of operating leverage (DOL) for each company. Which company benefits more from a 20% increase in sales.

Answer 1

degree of operating leverage (DOL) = fixed costs / total costs

Company A:

variable costs = total sales x (1 - contribution margin) = $3,300,000 x 40% = $1,320,000

fixed costs = $1,450,000

total costs = $2,770,000

DOL = $1,450 / $2,770 = 52.35%

530 - 926

Company B:

variable costs = total sales x (1 - contribution margin) = $3,200,000 x 70% = $2,240,000

fixed costs = $460,000

total costs = $2,700,000

DOL = $460 / $2,700 = 17.04%

600 - 692

Company A benefits more form a 20% increase in total sales. Currently, company A has an operating profit = $530,000. If sales increase by 20%, its operating profit will increase to $926,000.