An investment banker is analyzing two companies that specialize in the production and sale of candied yams. Traditional Yams uses a labor-intensive approach, and Auto-Yams uses a mechanized system. CVP income statements for the two companies are shown below.

Traditional Yams Auto-Yams Sales $400,000 $400,000 Variable costs 320,000 160,000 Contribution margin 80,000 240,000 Fixed costs 30,000 190,000 Net income $ 50,000 $ 50,000.

The investment banker is interested in acquiring 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 sales volume.

(b) Determine the effect on each company’s net income if sales decrease by 15% and if sales increase by 10%. Do not prepare income statements.

(c) Which company should the investment banker acquire? Discuss.AppendixLO1