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Operating leverage is high in rms with a high

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Unformatted text preview: Southwest Airlines and Jet Blue Airlines, have lower labor costs and operate out of lower cost and less-congested airports. Therefore, the operating leverage of American Airlines is higher than that of Jet Blue. Operating leverage is high in firms with a high proportion of fixed costs and a low proportion of variable costs and results in a high contribution margin per unit. The higher the firm’s fixed costs, the higher the break-even point. Once the break-even point has been reached, however, profit increases at a high rate. Exhibit 3.5 demonstrates the primary differences between two companies, Lo-Lev Company (with relatively high variable costs) and Hi-Lev Company (with relatively high fixed costs). Orientation CHAPTERS IN PART ONE 1 Making Yourself Successful in College 2 Approaching College Reading and Developing a College-Level Vocabulary 3 Approaching College Assignments: Reading Textbooks and Following Directions Different industries have different cost structures. Electric utilities (left) have high fixed costs and high operating leverage. Grocery stores (right) have lower fixed costs and low operating leverage. Exhibit 3.5 Lo-Lev Company (1,000,000 units) Comparison of Cost Structures Amount Sales . . . . . . . . . . . . Variable costs . . . . . . Contribution margin . . Fixed costs . . . . . . . . Operating profit . . . . Percentage $1,000,000 750,000 _________ $ 250,000 50,000 _________ $ 200,000 _________ _________ 100 75 25 5 20 Break-even point . . . 200,000 units Contribution margin per unit $0.25 cor50782_ch01_001-072.indd 1 lan27114_ch03_080-109.indd 88 ✓ Related Resources See pages 000 to 000 Hi-Lev Company (1,000,000 units) of the Annotated Instructor’s Edition for general suggesAmount Percentage tions related to the chapters in $1,000,000 100 Part One. 250,000 _________ $ 750,000 550,000 _________ $ 200,000 _________ _________ 733,334 units $0.75 25 75 55 20 1 10/5/09 11:09:29 PM 10/23/09 4:49:33 AM REVISED PAGES Chapter 3 Fundamentals of Cost-Volume-Profit Analysis 89 Effect of Cost Structure on Operating PART and Investing Decisions In Action Different cost structures lead to different decisions that firms make concerning operations and investments. Consider the following two statements: 1. 2. “Ahold now has about $23 billion in sales among its six U.S. supermarket chains—large but uncomfortably behind giants such as Wal-Mart, Kroger, and Albertson’s. The logic of consolidation is that, in a business with such slim profit margins, bigger companies gain important competitive advantage by being able to negotiate better terms and prices from suppliers, better rents from landlords and better advertising deals from media outlets” (Washington Post, February 8, 2004). “Many experts say the airlines throw planes on a route to grab market share from rivals. Robert L. 1 Crandall, the former chief executive of American Airlines, said that airlines added planes because growth spreads fixed costs over more passenger miles. ‘If everyb...
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