All other things the same, in periods of increasing sales, net operating income will tend to...

All other things the same, in periods of increasing sales, net operating income will tend to increase more rapidly in a company with high fixed costs and low variable costs than in a company with high variable costs and low fixed costs.

Expert Solution

True

The companies having high fixed cost will show high percentage of increase in income with change in sales in comparison to companies having high variable cost. This is also explained in the given below example where Company A shows high increase in income in comparison to company B simply because company A has higher fixed cost component in its cost structure.

		Company A	Company B
A	Sales	$ 5,00,000.00	$ 5,00,000.00
B	Variable cost	$ 1,00,000.00	$ 4,00,000.00
C=A-B	Contribution margin	$ 4,00,000.00	$ 1,00,000.00
D	Fixed cost	$ 2,50,000.00	$ 50,000.00
E=C-D	Net Income	$ 1,50,000.00	$ 50,000.00
F=C/E	Degree of operating leverage	2.67	2.00
G	% Increase in sales	10%	10%
H=F x G	% Increase in net income	27%	20%

This takes place because fixed cost is same at all levels and when sales increase the fixed cost do not change which gioves a higher contribution margin than a high variable cost company.

ekkarill92 answered 10 months ago

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