Dan Wenman has approached your bank for a loan to start a hazardous waste management business. There are a number of biotechnology and chemical companies in Dan’s community, and such companies generate a fair amount of hazardous medical, chemical, and radioactive waste. Dan wants to start a business that focuses on all aspects of the waste management process; his goal is to provide for the safe and cost-effective storage, transportation, and disposal of industrial waste.

Dan has approached your bank with two proposals. His first proposal calls for him to “go it alone.” As such, Dan would be responsible for acquiring all of the necessary personnel, equipment, and facilities for waste treatment. Under this proposal, Dan expects to incur fixed costs of $1,500,000 per year. His expected contribution margin ratio is 60%. The second proposal calls for Dan to outsource the disposal portion of his business (i.e., Dan would focus on the containment and transportation of waste). Here, Dan would enlist (and pay for) the services of a privately owned landfill, waste combustor, and incinerator

(rather than buying his own landfill, waste combustor, and incinerator). The benefit of this option is that it reduces Dan’s fixed costs to $675,000 per year. The cost, however, is that Dan’s contribution margin ratio would decrease to 30%. Dan is confident that both options are comparable on all other dimensions, such as quality and safety.

Required:

a. Suppose Dan estimates that revenues from his business will be $2,750,000 per year. What is Dan’s profit under each proposal? What is Dan’s operating leverage under each proposal? What is Dan’s margin of safety under each proposal? As Dan’s potential lender, which proposal would you likely support?

b. Suppose Dan estimates that sales revenue from his business will be $4,500,000 per year. What is Dan’s profit under each proposal? What is Dan’s operating leverage under each proposal? What is Dan’s margin of safety (in $) under each proposal? As Dan’s potential lender, which proposal would you likely support?