Question

Operating Leverage

Income statements for two different companies in the same industry are as follows:

		Trimax, Inc.		Quintex, Inc.
Sales		$240,000		$375,000
Less: Variable costs		120,000		75,000
Contribution margin		$120,000		$300,000
Less: Fixed costs		90,000		270,000
Operating income		$30,000		$30,000

Required:

1. Compute the degree of operating leverage for each company.

Trimax
Quintex

2. Compute the break-even point in dollars for each company.

Trimax, Inc.	$
Quintex, Inc.	$

Why is the break-even point for Quintex, Inc., higher?

3. Suppose that both companies experience a 60 percent increase in revenues. Compute the percentage change in profits for each company.

Trimax		%
Quintex		%

Answer 1

Degree of operating leverage = Contribution margin /Operating income

Trimax (120,000/30,000)	4
Quintex (300,000/30,000)	10

Contribution margin ratio of

Trimax = 120,000/240,000 = 50%

Quintex = 300,000/375,000 = 80%

Breakeven point in dollars = Fixed cost/Contribution margin ratio

Trimax (90,000/50%)	180,000
Quintex (270,000/80%)	337,500

Because it has to cover more fixed costs

3. Increase in net income = (DOL*% Increase in sales)

Trimax (4*60)%	240%
Quintex (10*60)%	600%