Answer:
See below
Explanation:
Company A
Degree of operating leverage is computed as
= Contribution margin / Net income
Net income = Contribution margin - Fixed costs
= 60% × $6,000,000 - $2,600,000
= $3,600,000 - $2,600,000
= $1,000,000
Degree of operating leverage = $3,600,000 /$1,000,000
= 3.6
Company B
Degree of operating leverage is computed as
= Contribution margin / Net income
Net income = Contribution margin - Fixed costs
= 25% × $4,500,000 - $375,000
= $1,125,000 - $375,000
= $750,000
Degree of operating leverage = $4,500,000 / $750,000
= 6
• 20% increase in sales company A
Sales = 20% × $6,000,000 + $6,000,000 = $7,200,000
Net income = 60% × $7,200,000 - $2,600,000 = $1,720,000
Degree of operating leverage = $4,320,000 / $1,720,000 = 2.5
• 20% increase in sales company B
Sales = 20% × $4,500,000 + $4,500,000 = $5,400,000
Net income = 25% × $5,400,000 - $375,000 = $975,000
Degree of operating leverage = $1,350,000 /$975,000 = 1.38
With regards to the above, company A tends to gain more from the sales increase because its operating leverage of 2.5 is more than that of company B, whose operating leverage is 1.38
