Question

HighTech, Inc., and OldTime Co. compete within the same industry and had the following operating results in 2015:

	HighTech, Inc.				OldTime Co.
Sales	$	3,300,000			$	3,300,000
Variable expenses		660,000				1,980,000
Contribution margin	$	2,640,000			$	1,320,000
Fixed expenses		2,140,000				820,000
Operating income	$	500,000			$	500,000

Required:

a. Calculate the break-even point for each firm in terms of revenue. (Do not round intermediate calculations.)

b. What observations can you draw by examining the break-even point of each firm given that they earned an equal amount of operating income on identical sales volumes in 2015?

	The breakeven point for each firm is different because each firm has a different amount of fixed costs to be recovered.
	The breakeven point for both firms is same because both the firms have same amount of fixed costs to be recovered.

c.1 Calculate the amount of operating income (or loss) that you would expect each firm to report in 2016 if sales were to increase by 20%. (Losses should be indicated by minus sign.)

c.2 Calculate the amount of operating income (or loss) that you would expect each firm to report in 2016 if sales were to decrease by 20%. (Losses should be indicated by minus sign.)

d. Using the amounts computed in requirement c, calculate the increase or decrease in the amount of operating income expected in 2016 from the amount reported in 2015.

e. Explain why an equal percentage increase (or decrease) in sales for each firm would have such differing effects on operating income.

	HighTech, Inc. has significantly more operating leverage than does OldTime Co. because its fixed costs are much higher and its contribution margin ratio is also much higher.
	OldTime Co. has significantly more operating leverage than does HighTech, Inc. because its fixed costs are much higher and its contribution margin ratio is also much higher.

f. Calculate the ratio of contribution margin to operating income for each firm in 2015. (Do not round intermediate calculations and round your final answers to 2 decimal places.)

g. Multiply the expected increase in sales of 20% for 2016 by the ratio of contribution margin to operating income for 2015 computed in requirement f for each firm. (Do not round intermediate calculations and round your final answers to 2 decimal places.)

h. Multiply your answer in requirement g by the 2015 operating income given in the problem. (Do not round intermediate calculations.)

Answer 1

a.

Contribution margin ratio = Total contribution/Sales

Breakeven sales in dollar = Fixed cost/CM ratio

Contribution margin ratio for high-tech, Inc. = $ 2,640,000/$ 3,300,000 = 0.8

Breakeven sales in dollar for high-tech, Inc. = $ 2,140,000/0.8 = $ 2,675,000

Contribution margin ratio for OldTime, Co. = $ 1,320,000/$ 3,300,000 = 0.4

Breakeven sales in dollar OldTime, Co. = $ 820,000/0.4 = $ 2,050,000

b.

The breakeven point of each firm is different because each firm has a different amount of fixed costs to be recovered.

c.1

	HighTech, Inc	OldTime, Co.
Sales	$       3,960,000	$     3,960,000
Less: Variable expenses	$           792,000	$     2,376,000
Contribution Margin	$       3,168,000	$    1,584,000
Less: Fixed expenses	$       2,140,000	$       820,000
Operating income	$       1,028,000	$       764,000

Computation of expected sales and Variable expenses in 2016:

Revised sales for both the firm = $ 3,300,000 x 1.2 = $ 3,960,000

Variable expenses for HighTech, Inc = Sales x 0.2 = $ 3,960,000 x 0.2 = $ 792,000

Variable expenses for OldTime, Co. = Sales x 0.6 = $ 3,960,000 x 0.6 = $ 2,376,000

c.2

	HighTech, Inc	OldTime, Co.
Sales	$   2,640,000	$           2,640,000
Variable expenses	$       528,000	$           1,584,000
Contribution Margin	$    2,112,000	$           1,056,000
Fixed expenses	$    2,140,000	$              820,000
Operating income	-$         28,000	$               236,000

Computation of expected sales and Variable expenses in 2016:

Revised sales for both the firm = $ 3,300,000 x (100 % - 20 %) =

                                            = $ 3,300,000 x 0.8 = $ 2,640,000

Variable expenses for HighTech, Inc = Sales x 0.2 = $ 2,640,000 x 0.2 = $ 528,000

Variable expenses for OldTime, Co. = Sales x 0.6 = $ 2,640,000 x 0.6 = $ 1,584,000

d.

On increasing sales by 20 %,

Operating income of HighTech, Inc for 2016 increased by $ 528,000 (i.e. $ 1,028,000 - $ 500,000)

Operating income of OldTime, Co. for 2016 increased by $ 264,000 (i.e. $ 764,000 - $ 500,000)

On decreasing sales by 20 %,

Operating income of HighTech, Inc decreased by $ 528,000   [i.e. $ 500,000 – (- $ 28,000]

Operating income of OldTime, Co. decreased by $ 264,000 (i.e. $ 764,000 - $ 500,000)

e.

Reason for unequal change in operating income for equal % changes in sales is:

HighTech, Inc has significantly more operating leverages than does OldTime, Co. because its fixed costs are much higher and its contribution margin ratio is also much higher

****Answered for 4 + 2 sub parts against minimum 4 sub parts.