Question

Bergen Hospital is contemplating an investment in an automated surgeical system. Its current process relies on the a number of skilled physicians. The new equipment would employ a computer robotic system operated by a technician. The company requested an analysis of the old technology versus the new technology. The accounting department has prepared the following CVP income statements for use in your analysis. Old New Sales $2,905,000 $2,905,000 Variable costs 1,611,250 679,000 Contribution margin 1,293,750 2,226,000 Fixed costs 1,068,750 1,946,000 Net income $225,000 $280,000 (a) Compute the degree of operating leverage for the company under each scenario. (Round answers to 2 decimal places, e.g. 15.72.) Degree of operating leverage Old New

Answer 1

	Old Technology	New Technology
Degree of operating leverage	5.75	7.95

a) Calculation of Degree of operating leverage is as folllows:

Old Technology:

Operating leverage = Contribution margin / Net Income

= $ 1,293,750 / $ 225,000

= 5.75 times

Interpretation of operating leverage: If sales increase by change by 10% then Net income will be change by 57.5%

New Technology:

Operating leverage = Contribution margin / Net Income

= $ 2,226,000 / $ 280,000

= 7.95 times

Interpretation of operating leverage: If sales increase by change by 10% then Net income will be change by 79.5%

Working note:

CVP Income statement

	Old Technology	New Technology
Sales	$          29,05,000	$            29,05,000
Variable cost	$          16,11,250	$               6,79,000
Contribution margin	$          12,93,750	$            22,26,000
Fixed cost	$          10,68,750	$            19,46,000
Net income	$             2,25,000	$               2,80,000