Question

arnold vimka is a venture capitalist facing two alternative investment opportunities. he intends to invest $1,000,000 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 years operations of the two firms he is considering and give him some business advice.

required

a. use the contribution margin approach to compute the operating leverage for each firm.
b. if the economy expands in coming years, larson and benson will both enjoy a 11 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.)
c. if the economy contracts in coming years, larson and benson will both suffer a 11 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.)

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

Explanation:

Step1: Recall the formula for operating leverage

Operating leverage = Contribution margin / Net income

Step2: Calculate for Larson

Contribution margin for Larson = $88,000$, Net income for Larson = $63,800$
Operating leverage for Larson = $\frac{88000}{63800}\approx1.38$

Step3: Calculate for Benson

Contribution margin for Benson = $176,000$, Net income for Benson = $63,800$
Operating leverage for Benson = $\frac{176000}{63800}\approx2.76$

Answer:

Larson's operating leverage is approximately $1.38$, Benson's operating leverage is approximately $2.76$.