Part a

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

The investment banker is interested in acquiring one of these companies. However, she is concerned about the impact that each companys cost structure might have on its profitability

Instructions

1. Calculate each companys degree of operating leverage. Determine which companys cost structure makes it more sensitive to changes in sales volume. (2)
2. Determine the effect on each companys net income if sales decrease by 10% and if sales increase by 5%. Do not prepare income statements. (2)
3. Which company should the investment banker acquire? Discuss. (2)

Sales Variable costs Contribution margin Fixed costs Net income Old-Fashion Apples $400,000 320,000 80,000 20,000 $ 60,000 Mech-Apple $400,000 160,000 240,000 180,000 $ 60,000