Question

Problem 2 (18 minutes) The Bruggs & Strutton Company manufactures an engine for carpet cleaners called the "Snooper." Budgeted cost and revenue data for the coming month of the "Snooper" are given below, based on sales of 40,000 units. Sales (40,000 units) $1,600,000 Less: Cost of goods sold 1,120,000 Gross margin $ 480,000 Less: Operating expenses 100,000 Operating income $ 380,000 Cost of goods sold consists of $800,000 of variable costs and $320,000 of fixed costs. Operating expenses consist of $40,000 of variable costs and $60,000 of fixed costs. Required: a. Calculate the break-even point in units. b. How many units must be sold to generate an operating income equal to 15% of sales? c. Using the degree of operating leverage, calculate the percentage increase in operating income that would result if sales were to increase by 25% over the budgeted amount. d. Management wants to increase sales and feels that this can be done by cutting the selling price by 10% and increasing the advertising budget by $20,000 per month. Management believes that these actions will increase unit sales by 50%. Should these changes be made? Use incremental analysis.

Answer 1

	Solution
(a)	Break Even Point in Units	=	Fixed Cost / Contribution Per Unit
	Total Fixed Cost		Cost of Goods Sold	320,000
			Operating Expenses	60,000
				380,000
	Total Variable Cost		Cost of Goods Sold	800,000
			Operating Expenses	40,000
				840,000
	Contribution = Sales - Variable costs
	Sales	1,600,000
	Total Variable Cost	840,000
	Contribution	760,000
	Units Sold	40,000
	Contribution per unit	19
	Break Even Point in Units
	Total Fixed Cost	380,000
	Contribution per unit	19
		20,000 Units

(b)	Units must be sold to generate an Operating income equal to 15% of Sales.
	Sales	1,600,000
	15% of Sales	240,000	(1600000*15%)
	Operating Income for 40,000 Units	380,000
	Operating Income Per unit	9.50	(380,000/40000)
	Operating Income Required(15% of Sales)	240,000
	Operating Income Per unit	9.50
	Units Requred	25,263.16	(240,000/9.50)
	Units must be sold to generate an Operating income equal to 15% of Sales.
		25,264 Units

( c )	Degree of Operating Leverages is a cost accounting equation which gives the degree to which a firm can increase operating income
	by increasing revenue.
	Degree of Operating Leverages = Contribution Margin / Profit
	this can be re write as
	Degree of Operating Leverages = Contribution Margin / (Contribution margin - Fixed Cost)
	Contribution margin	760,000
	Total Fixed Cost	380,000
	Contribution margin - Fixed Cost	380,000
	Degree of Operating Leverages	200%	(760000/380000)
	Increase in Sales	25%
	percentage Increase in Operating Income	50%	(25%*200%)
	Note
	Operating Leverages 200% means if sales increase by 25% Operating Income will increase by 50 %.

(d)	Selling Price per Unit = Sales / Units
	Selling Price per Unit
	Sales	1,600,000
	Units	40,000
		40	Per Unit
	New Selling Price(cutting by 10%)	36	Per Unit
	Variable Cost per Unit = Variable Cost / Units
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