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YAMS Company

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An investment banker is analyzing two companies that specialize in the production
and sale of candied yams. Traditional Yams uses a labor-intensive approach, and
Auto-Yams uses a mechanized system. CVP income statements for the two companies are
shown below.

  Traditional Yams Auto Yams
Sales  400,000  400,000
Variable costs   320,000  160,000
Contribution margin  80,000  240,000
Fixed costs  30,000   190,000
Net income  50,000  50,000

The investment banker is interested in acquiring one of these companies. However, she
is concerned about the impact that each company’s cost structure might have on its

(a) Calculate each company’s degree of operating leverage. Determine which company’s
cost structure makes it more sensitive to changes in sales volume.
(b) Determine the effect on each company’s net income if sales decrease by 15% and if
sales increase by 10%. Do not prepare income statements.
(c) Which company should the investment banker acquire?

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