Question

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

	HighTech, Inc.				OldTime Co.
Sales	$	3,500,000			$	3,500,000
Variable expenses		700,000				2,100,000
Contribution margin	$	2,800,000			$	1,400,000
Fixed expenses		2,270,000				870,000
Operating income	$	530,000			$	530,000

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.)

i. Compare your answer in requirement h with your answer in requirement d. What conclusions can you draw about the effects of operating leverage from the steps you performed in requirement f, g, and h?

	The answer calculated in requirement (h) is equal to the answer calculated in requirement (d).
	The answer calculated in requirement (h) is higher than the answer calculated in requirement (d).
	The answer calculated in requirement (h) is lower than the answer calculated in requirement (d).

Answer 1

		High Teck	Old Time
A	Sale	3500000	3500000
B	Variable	700000	2100000
A-B=C	Contribution Margin	2800000	1400000			80
D	Fixed Expense	2270000	870000
C-D=E	Operating Income	530000	530000
Working	Contribution Margin Ratio (C/A*100)	80	40
a	Break Even point	2270000/80%	870000/40%
	(Fixed Expense/Cont Margin Ratio)
		2837500	2175000
b	The breakeven point for each firm is different because each firm has a different amount of fixed costs to be recovered.
c1 and c2		Increase in sale by 20%			decrease in sale by 20%
		High Teck	Old Time		High Teck	Old Time
	Given Sale	3500000	3500000		3500000	3500000
	Increase/(Decrease) 20%	700000	700000		-700000	-700000
	Sale	4200000	4200000		2800000	2800000
	Variable (Sale-Cont Margin)	840000	2520000		560000	1680000
	Contribution Margin (Sale*Cont Margin 80 and 40)	3360000	1680000		2240000	1120000
	Fixed Expense (Same)	2270000	870000		2270000	870000
	Operating Income	1090000	810000		-30000	250000
d		2015	Increase 20%	Decrease 20%
	High Teck	530000	1090000	-30000
	Old Time	530000	810000	250000
	Increase/Decrease
	High Teck		(1090000-530000)/530000	(-30000-530000)/530000
	Old Time		(810000-530000)/530000	(250000-530000)/530000
	High Teck	%increase/(Decrease)	105.66	-105.66
	Old Time	%increase/(Decrease)	52.83	-52.83
e	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.
f		High Teck	Old Time
	Cont Margin	2800000	1400000
	Operating Income	530000	530000
	Ratio of contribution margin to Operating income	5.28	2.64
	(Cont Margin/Op Income)