Question

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $80 per unit. Variable expenses are $40.00 per unit, and fixed expenses total $160,000 per year. Its operating results for last year were as follows:

Sales	$	2,080,000
Variable expenses		1,040,000
Contribution margin		1,040,000
Fixed expenses		160,000
Net operating income	$	880,000

Required:

Answer each question independently based on the original data:

1. What is the product's CM ratio?

2. Use the CM ratio to determine the break-even point in dollar sales.

3. Assume this year’s unit sales and total sales increase by 41,000 units and $3,280,000, respectively. If the fixed expenses do not change, how much will net operating income increase?

4-a. What is the degree of operating leverage based on last year's sales?

4-b. Assume the president expects this year's unit sales to increase by 16%. Using the degree of operating leverage from last year, what percentage increase in net operating income will the company realize this year?

5. The sales manager is convinced that a 13% reduction in the selling price, combined with a $78,000 increase in advertising, would increase this year's unit sales by 25%.

a. If the sales manager is right, what would be this year's net operating income if his ideas are implemented?

b. If the sales manager's ideas are implemented, how much will net operating income increase or decrease over last year?

6. The president does not want to change the selling price. Instead, he wants to increase the sales commission by $2.40 per unit. He thinks that this move, combined with some increase in advertising, would increase this year's unit sales by 25%. How much could the president increase this year's advertising expense and still earn the same $880,000 net operating income as last year?

Answer 1

Given information

1. Contribution margin ratio = (Sales - variable cost)/sales

= (2080000 - 1040000)/2040000

= 1040000/2040000

= 50%

2. BEP (in dollar sales) = Total fixed cost/contribution margin ratio

= 160000/50%

= $ 320000

3. unit sales increase by 41000

total sales increase by = $ 3280000

increase in net operating income = conribution margin per unit*41000

= 40*41000

= $ 1640000

4. (a) Degree of operating leverage based on last year sales = contribution /EBIT

= 1040000/880000

= 1.1818

4 (b) DOL = % change in EBIT/% change in sales

1.1818 = % change in EBIT/16%

% change in EBIT = 18.9091%

5. (a) New selling price per unit = $ 80 - 13%of $80

= 80 - 10.4

=$ 69.6

increase in advertising cost/fixed = $ 78000

new fixed expense = 160000 + 78000

= $ 238000

increase in unit sales = 25% of earlier sales

new sales = 26000 + 25% of 26000 units

= 26000 + 6500

= 32500 units

New net operating income = (New selling price per unit - variable cost per unit)*New sales volume - new fixed cost

= (69.6 - 40)*32500 - 238000

= 962000 - 238000

= $ 724000

5(b) impact on Net operating income = New net operating income - earlier net operating income

= 724000 - 880000

= $ 156000

net operating income decrease over last year.

6. new variable cost per unit = 40 + 2.4(commission)

= $ 42.4

selling price per unit = $ 80

new sales volume = 26000 + 26000*25%

= 26000 + 6500

= 32500

net operating income = $ 880000

increase in fixed cost/advertising expense to earn $ 880000 = ?

(Selling price per unit - new variable cost per unit)*new sales volume - fixed cost - increase in advertising expense = desired net operating income

(80 - 42.4)*32500 - 160000 - x = 880000

37.6*32500 - 160000 - x = 880000

1222000 - 160000 - 880000 = x

x = 182000

increase in advertising cost = $ 182000.

Please check with your answer and let me know.