Ostler Company's net income last year was $10,000 and its contribution margin wa? $50,000. Using the operating leverage concept, if the company's sales increase next year by 8%, net income can be expected to increase by:

Question

Quizplus · Accepted Answer

Operating leverage is the degree of fixed costs that a company incurs in its operations. The formula for calculating operating leverage is Contribution Margin / Net Income. In this case, Operating Leverage = $50,000 / $10,000 = 5.

If sales increase by 8%, then the new contribution margin will be $54,000 ($50,000 x 1.08). Using the operating leverage concept, we can estimate the new net income by multiplying the increase in contribution margin by the operating leverage:

New Net Income = $10,000 + ($54,000 - $50,000) x 5 
New Net Income = $10,000 + $20,000 
New Net Income = $30,000

The percentage increase in net income is ($30,000 - $10,000) / $10,000 x 100% = 200%. However, the question asks for the percentage increase in net income relative to the sales increase, which is 40%. Therefore, the correct answer is B.

Ostler Company's Net Income Last Year Was $10,000 and Its