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12.Award: 10.00 pointsProblems? Adjust credit for all students.Exercise 18-24 Operating leverage computed and applied LO A2Company A is a manufacturer with current sales of $6,000,000 and a 60% contribution margin. Its fixed costs equal$2,600,000. Company B is a consulting firm with current service revenues of $4,500,000 and a 25% contributionmargin. Its fixed costs equal $375,000.Compute the degree of operating leverage (DOL) for each company.$$$$$$$$Contribution Margin Income StatementCompany ACompany BSales6,000,0004,500,000Variable costs2,400,0003,375,000Contribution margin3,600,0001,125,000Fixed costs2,600,000375,000Pretax income1,000,000750,000Degree of operating leverageChoose:Numerator/Denominator=RatioContribution margin/Pretax income=Degree of Operating LeverageCompany A3,600,0001,000,000Company B1,125,000750,000/=3.6/=1.5FFFFFFIdentify which company benefits more from a 20% increase in sales.Company ACompany BExplanation:Company AVariable costs [$6,000,000 × (100% – 60%)] = $2,400,000Contribution margin ($6,000,000 × 60%) = $3,600,000Company BVariable costs [$4,500,000 × (100% – 25%)] = $3,375,000Contribution margin ($4,500,000 × 25%) = $1,125,000Interpretation: Company A benefits more from a 20% increase in sales. This is because we expect a 20% increasein sales to yield a 72% increase in income (computed as 3.6 × 20%). For Company B we expect a 20% increase insales to yield a 30% increase in income (computed as 1.5 × 20%). Note that although Company A’s fixed costs arehigher, its increase in income is greater than that for Company B due to its higher degree of operating leverage (3.6versus 1.5).ReferencesHints