Question

You are considering buying one of two local firms (Olson Corporation and Miami Inc.) Olson Corporation uses a substantial amount of direct labor in its manufacturing operations, and its salespeople work on commission. Miami Inc. uses the latest automated technology in manufacturing; its salespeople are salaried. The following financial information is available for the two companies:

                                                            OLSON CORP. MIAMI INC.  

                                                   2013                 2014 2013                   2014

     Sales                                   $ 600,000       $ 960,000 $ 600,000      $     840,000

     Expenses including taxes      (528,000)        (823,200) (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 Olson Corporation is $60,000; the fixed cost for Miami Inc. is $300,000. The tax rate for both companies is 40 percent.

e.     Assume that product demand for 2015 is expected to rise by 15 percent from the 2014 level. What will be the expected net income for each firm?

f.     Assume that product demand for 2015 is expected to fall by 20 percent from the 2014 level. What will be the expected net income for each firm?

Answer 1

(e). When product demand for 2015 is expected to rise by 15 percent from the 2014 level;

	2015
	OLSON CORP.	MIAMI INC.
Sales (15% higher than 2014)	$1104000	$966000
Less:
Variable expenses (15% higher than 2014)	($772800)	($289800)
Contribution margin	$331200	$676200
Less: Fixed costs	($60000)	($300000)
Income before tax	$271200	$376200
Less: Income tax @40%	($108480)	($150480)
Net income	$162720	$225720

(e). When product demand for 2015 is expected to fall by 20 percent from the 2014 level;

	2015
	OLSON CORP.	MIAMI INC.
Sales (20% lower than 2014)	$768000	$672000
Less:
Variable expenses (20% lower than 2014)	($537600)	($201600)
Contribution margin	$230400	$470400
Less: Fixed costs	($60000)	($300000)
Income before tax	$170400	$170400
Less: Income tax @40%	($68160)	($68160)
Net income	$102240	$102240