P2-23A Analyzing operating leverage (Req A to C only)
Justin Zinder 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
Ensley Kelley
Variable cost per unit (a) $21.00 $10.50
Sales revenue (8,000 units × $28.00) $224,000 $224,000
Variable cost (8,000 units × a) (168,000) (84,000)
Contribution margin $56,000 $140,000
Fixed cost (25,000) (109,000)
Net income $31,000 $31,000
Required:
a. Use the contribution margin approach to compute the operating leverage for each firm. (Round your answers to 2 decimal places.)
b. If the economy expands in coming years, Ensley and Kelley will both enjoy a 10 percent per year increase in sales, assuming that the selling price remains unchanged. Compute the new net income for each firm and percentage change in net income. (Use unrounded values of operating leverage for calculation purpose.
Round your net income answers to the nearest dollar amount and percentage change answers to 2 decimal places. Omit the “$” and “%” signs in your response.)
c. If the economy contracts in coming years, Ensley and Kelley will both suffer a 10 percent decrease in sales volume, assuming that the selling price remains unchanged. Compute the new net income for each firm and percentage change in net income. (Use unrounded values of operating leverage for calculation purpose.
Negative values should be indicated by a minus sign. Round your net income answers to the nearest dollar amount and percentage change answers to 2 decimal places. Omit the “$” and “%” signs in your response.)