Question

Company A is a manufacturer with sales of $3,200,000 and a 50% contribution margin. Its fixed costs equal $1,080,000. Company B is a consulting firm with service revenues of $3,100,000 and a 25% contribution margin. Its fixed costs equal $280,000. Compute the degree of operating leverage (DOL) for each company. Which company benefits more from a 20% increase in sales.

Compute the degree of operating leverage (DOL) for each company.

Which company benefits more from a 20% increase in sales.

Answer 1

	Company A	Company B
Sales	$3,200,000	$3,100,000
Less : Variable costs	$1,600,000	$2,325,000
Contribution margin	$1,600,000	$775,000
Less : Fixed costs	$1,080,000	$280,000
Operating income	$520,000	$495,000

Compute the degree of operating leverage (DOL) for each company.

Degree of operating leverage = Contribution margin / Operating income

	Company A	Company B
Degree of operating leverage	3.08 times ($1,600,000/$520,000)	1.57 times ($775,000/$495,000)

Which company benefits more from a 20% increase in sales.

The answer is Company A.