Question

Consolidated Industries is studying the addition of a new valve to its product line. The valve would be used by manufacturers of irrigation equipment. The company anticipates starting with a relatively low sales volume and then boosting demand over the next several years. A new salesperson must be hired because Consolidated’s current sales force is working at capacity. Two compensation plans are under consideration:

Plan A: An annual salary of $22,000 plus a 10% commission based on gross dollar sales.

Plan B: An annual salary of $66,000 and no commission.

Consolidated Industries will purchase the valve for $50 and sell it for $80. Anticipated demand during the first year is 6,000 units. (In the following requirements, ignore income taxes.)

3-a. Compute the operating leverage factor of both plans at the anticipated demand of 6,000 units

Answer 1

Operating Leverage =

Contribution Margin/Operating Income

Plan A Operating Income

Sales (80*6,000) 480,000

- Variable Cost (50*6,000) 300,000

- Commission (480,000*10%) 48,000

Contribution Margin 132,000

- Fixed Cost 22,000

Operating Income 110,000

Operating Leverage = 132,000/110,000

= 1.2

Plan B Operating Income:-

Sales 480,000

- Variable Cost 300,000

Contribution Margin 180,000

- Fixed Cost 66,000

Operating Income 114,000

Operating Leverage = 180,000/114,000

= 1.58