Question

Multiple Products, Break-Even Analysis, Operating Leverage

Carlyle Lighting Products produces two different types of lamps: a floor lamp and a desk lamp.

Floor lamps sell for $30 and desk lamps sell for $20.

The projected income statement for the upcoming year follows:

Sales                                  $600,000

Less: Variable costs            400,000

Contribution margin            200,000

Less: Fixed costs                 150,000

Operating income                $50,000

The owner of Carlyle’s estimates that 60 percent of the sales revenues will be produced by floor lamps and the remaining 40 percent by desk lamps.

Floor lamps are also responsible for 60 percent of the variable expenses. Of the fixed expenses, one-third are common to both products, and one-half are directly traceable to the floor lamp product line.

Required:

1. Compute the degree of operating leverage for Carlyle Lighting Products. Now assume that the actual revenues will be 40 percent higher than the projected revenues.

2. By what percentage will profits increase with this change in sales volume? What is the theory behind the operating leverage concept?

Answer 1

Degree of the Operating Leverage :

Actual Revenue is 40 % higher than budgeted revenue = $ 600000 + 40% = $ 840000

Original Operating Income = $ 50000

Incremental Projected Operating Income : ( in $ )

Particular	Amount
Sales	840000
Variable costs	560000
Contribution margin	280000
Fixed Costs	150000
Operating income	130000

Operating Leverage : Contribution margin has remain the same 33.33 % & operating Income margin has increse from 8.33 % to 15.48 % , So 40% increse in sales amounts to incresing the operating revenue by 7.15%.

Degree of operating leverage :

DOL = % change in EBIT / % change in Sales

= 7.15 / 40

DOL = 0.17875