Beck Inc. Bryant Inc.
Sales $1,250,000 $2,000,000
Variable costs 750,000 1,250,000
Contribution margin $ 500,000 $ 750,000
Fixed costs 400,000 450,000
Income from operations $ 100,000 $ 300,000
a. Compute the operating leverage for Beck Inc. and Bryant Inc.
b. How much would income from operations increase for each company if the sales of each increased by 20%?
c. Why is there a difference in the increase in income from operations for the two companies? Explain.
Answer:
a. Beck Inc.:
Operating Leverage = Contribution Margin
Income from Operations
Operating Leverage = $500,000
$100,000
= 5.0
Bryant Inc.:
Operating Leverage = Contribution Margin
Income from Operations
Operating Leverage = $750,000
$300,000
= 2.5
b. Beck Inc.’s income from operations would increase by 100% (5.0 × 20%), or $100,000 (100% × $100,000), and Bryant Inc.’s income from operations would increase by 50% (2.5 × 20%), or $150,000 (50% × $300,000).
c. The difference in the increases of income from operations is due to the difference in the operating leverages. Beck Inc.’s higher operating leverage means that its fixed costs are a larger percentage of contribution margin than are Bryant Inc.’s. Thus, increases in sales increase operating profit at a faster rate for Beck Inc. than for Bryant Inc.