An investment banker is analyzing two companies that specialize in the production and sal e
of candied yams. Traditional Yams uses a labor-intensive approach, and Auto-Yams uses
a mechanized system. CVP income statements for the two companies are shown below.
The investment
banker is interested in acquiring one of these companies. However, she is concerned about the
impact that each company’s cost structure might have on its profitability.
Instructions
(a) Calculate each company’s degree of operating leverage. Determine which company’s
Traditional
Yams
cost structure makes it more sensitive to changes in sales volume.
(6 marks)
Auto-Yams
Sales $400,000 $400,000
Variable costs 320,000 160,000
Contribution margin 80,000 240,000
Fixed costs 30,000 190,000
Net income $50,000 $50,000