Company A's cost structure includes costs that are mostly variable, whereas Company B's cost structure includes costs that are mostly fixed. In a time of increasing sales, which company will tend to realize the most rapid increase in profits? Explain. (Tip: Use operating leverage.)
A) Company A, because it has a higher CM ratio due to lower variable costs.
B) Company B, because it has a higher CM ratio due to lower variable costs.
C) Company B, because it has a lower CM ratio due to higher variable costs.
D) Company A, because it has a lower CM ratio due to higher variable costs.
E) Company A, because it has a higher margin of safety.

Question

Quizplus · Accepted Answer

Company B will have a higher contribution margin ratio than Company A due to its lower variable costs. Thus, contribution margin (and net operating income) will increase more rapidly as sales increase.

Company A's Cost Structure Includes Costs That Are Mostly Variable