Question

Arnold Vimka is a venture capitalist facing two alternative investment opportunities. He intends to invest $1...

Arnold Vimka is a venture capitalist facing two alternative investment opportunities. He intends to invest $1 million in a start-up firm. He is nervous, however, about future economic volatility. He asks you to analyze the following financial data for the past year’s operations of the two firms he is considering and give him some business advice.

Company Name
Larson Benson
Variable cost per unit (a) $ 18.00 $ 9.00
Sales revenue (8,000 units × $32.00) $ 256,000 $ 256,000
Variable cost (8,000 units × a) (144,000 ) (72,000 )
Contribution margin $ 112,000 $ 184,000
Fixed cost (24,400 ) (96,400 )
Net income $ 87,600 $ 87,600

Required

  1. Use the contribution margin approach to compute the operating leverage for each firm.

  2. If the economy expands in coming years, Larson and Benson will both enjoy a 12 percent per year increase in sales, assuming that the selling price remains unchanged. Compute the change in net income for each firm in dollar amount and in percentage. (Note: Since the number of units increases, both revenue and variable cost will increase.)

  3. If the economy contracts in coming years, Larson and Benson will both suffer a 12 percent decrease in sales volume, assuming that the selling price remains unchanged. Compute the change in net income for each firm in dollar amount and in percentage. (Note: Since the number of units increases, both revenue and variable cost will increase.)

Use the contribution margin approach to compute the operating leverage for each firm. (Round your answers to 2 decimal places.)

Company Name
Larson Benson
Variable cost per unit $18.00 $9.00
Sales revenue
Variable cost
Contribution margin
Fixed cost
Net income
Percentage change % %

If the economy contracts in coming years, Larson and Benson will both suffer a 12 percent decrease in sales volume, assuming that the selling price remains unchanged. Compute the change in net income for each firm in dollar amount and in percentage. (Note: Since the number of units decreases, both total revenue and total variable cost will decrease.) (Negative values should be indicated with a minus sign. Round “Percentage change” to 2 decimal places.)

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Company Name
Larson Benson
Variable cost per unit $18.00 $9.00
Sales revenue
Variable cost
Contribution margin
Fixed cost
Net income
Percentage change % %

Homework Answers

Answer #1

a). Operating leverage= contribution margin/ net income

Larsons= 112,000/ 87,600 = 1.28 times

Benson = 184,000/ 87,600 = 2.1 times

b).

Larsons Benson
Variable Cost per unit $18 $9
Sales revenue 286720 286720
Variable Cost 144000 72000
Contribution margin 142720 214720
Fixed cost 24400 96400
Net income 118320 118320
% Change 35% 35%
c.
Larsons Benson
Variable Cost per unit $18 $9
Sales revenue 225280 225280
Variable Cost 144000 72000
Contribution margin 81280 153280
Fixed cost 24400 96400
Net income 56880 56880
% Change -35% -35%
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