Question

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		%		%

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%