An investment banker is analyzing two companies that specialize in the production and sale of candied apples. Old-Fashion Apples uses a labour-intensive approach, and Mech-Apple uses a mechanized system. Variable costing in- come statements for the two companies are shown below:

The investment banker wants to acquire one of these companies. However, she is concerned about the impact that each company's cost structure might have on its profitability.
Instructions
(a) Calculate each company's degree of operating leverage. Determine which company's cost structure makes it more sensitive to changes in its sales volume. Present your answer in terms of the contribution margin ratio.
(b) Determine the effect on each company's operating income (1) if sales decrease by 15% and (2) if sales increase by 10%. Do not prepare income statements.
(c) Determine which company the investment banker should acquire. Explain.

Transcribed Image Text:

Old-Fashion Apples $400,000 320,000 80,000 30,000 $50,000 Mech-Apple $400,000 160,000 240,000 190,000 50,000 Sales Variable costs Contribution margin Fixed costs Operating income