Question

4. LO.1–LO.3 & LO.5 (MS; DOL; PV graph) You are considering buying one of two local firms (Levesque’s Bisques, and McMahon’s Clams.). Levesque uses a substantial amount of direct labor in its manufacturing operations and its salespeople work on commission.

McMahon uses the latest automated technology in manufacturing; its salespeople are salaried. The following financial information is available for the two companies:

	Levesque’s Bisques		McMahon’s Clams
	2019	2020	2019	2020
Sales	$600,000	$960,000	$600,000	$840,000
Expenses including taxes	(528,000)	(832,200)	(528,000)	(667,200)
Net income	$72,000	$136,800	$72,000	$172,800

After examining cost data, you find that the fixed cost for Levesque is $60,000; the fixed cost for McMahon is $300,000. The tax rate for both companies is 40 percent.

a. Recast the income statements into a variable costing format.

b. What are the break-even sales for each firm for each year?

c. Assume that you could acquire either firm for $1,200,000, and you want an after-tax return of 12 percent on your investment. Determine what sales level for each firm would allow you to reach your goal.

d. What is the margin of safety for each firm for each year? What is the degree of operating leverage?

e. Assume that product demand for 2021 is expected to rise by 15 percent from the 2020 level. What will be the expected net income for each firm?

f. Assume that product demand for 2021 is expected to fall by 20 percent from the 2020 level. What will be the expected net income for each firm?

Answer 1

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