sult, materials are less expensive, but fixed overhead is higher. Process 2 involves purchasing all subcomponents from outside suppliers. The direct materials costs are higher, but fixed factory overhead is considerably lower. Relevant data for a sales level of 30,000 units follow: Process 1 Process 2 Sales $8,010,000 $8,010,000 Variable expenses 2,700,000
Lloyd Gettys, a client of Kevin Lomax, is considering two different processes to make his
product—process 1 and process 2. Process 1 requires Lloyd to manufacture subcomponents of the
product in-house. As a result, materials are less expensive, but fixed
involves purchasing all subcomponents from outside suppliers. The direct materials costs are higher, but
fixed factory overhead is considerably lower. Relevant data for a sales level of 30,000 units follow:
Process 1 Process 2
Sales $8,010,000 $8,010,000
Variable expenses 2,700,000 4,200,000
Contribution margin $5,310,000 $3,810,000
Less total fixed expenses 3,650,625 1,428,750
Operating income $1,659,375 $2,381,250
Unit selling price $267 $267
Unit variable cost $90 $140
Unit contribution margin $177 $127
a. Compute the degree of operating leverage for each process.
b. Suppose that sales are 20 percent higher than budgeted. By what percentage will operating income
increase for each process? What will be the increase in operating income for each system? What will be
the total operating income for each process?
c. What if unit sales are 10 percent lower than budgeted? By what percentage will operating income
decrease for each process? What will be the total operating income for each process?
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