Mr. Labler owns and operates Labac Inc. and Mr. Capler owns and operates Capac Inc. Both firms produce and sell a relatively new product called Acerr. Since the product is relatively new, these are the only two firms in the Acerr industry.
Labac is very labor intensive with very little machinery. In contrast, Capac is very capital intensive with little in the way of labor costs. Over the past few years, sales have been relatively stable with each firm receiving anywhere between 40% and 60% of industry sales. To help them understand the industry better, both firms agreed to share information on sales and costs.
Sales and cost data for the past two years, 2010 and 2011, are as follows:
2010 2011 2010 2011
Sales $800,000 $1,040,000 $800,000 $920,000
Variable Costs 600,000 780,000 200,000 230,000
Fixed Costs 100,000 100,000 500,000 500,000
Required: Answer each question separately indicating which response corresponds to which question.
1. Prepare income statements for both firms, for both years using the contribution margin income statement approach.
2. Calculate the contribution margin ratio for each company for each year.
3. Calculate the degree of operating leverage for both firms in 2010.
4. Calculate the volume of sales in dollars that Labac would have to have had in 2011 to achieve the profit realized by Capac in 2011.
5. Given the two firms had the same revenue and operating income in 2010, explain why Labac's operating income for 2011 is less than the operating income of Capac for 2011 given that Labac had a larger increase in sales. When answering this question, you must make use of the concept of degree of operating leverage or contribution margin ratio or both. Be precise in your explanation.
6. If there was an industry-wide downturn in the Acerr industry in 2012, which firm would be the most likely to incur a loss assuming each firm in the industry experiences the same percentage decrease in their sales. Also indicate exactly at what percentage decrease in sales a loss would begin to occur (round off to two decimal points). Show all supporting calculations.
Solution prepares income statement and calculates CM Ratio and DOL for each of the given firms.