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 $180,000 per year. Its operating results for last year were as follows:

Sales	$	2,000,000
Variable expenses		1,000,000
Contribution margin		1,000,000
Fixed expenses		180,000
Net operating income	$	820,000

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. If this year's sales increase by $41,000 and 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 sales to increase by 17%. 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 12% reduction in the selling price, combined with a $74,000 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 $1.60 per unit. He thinks that this move, combined with some increase in advertising, would increase this year's sales by 25%. How much could the president increase this year's advertising expense and still earn the same $820,000 net operating income as last year?

Answer 1

1. Caluculation of Product Contribution Margin

Product Contribution Margin
Sales (A)	$80
Variable Cost (B)	$40
Contribution (C) (A-B)	$40
Contribution Margin (C/A)	50%
2. Calculation of Break Even Point Sales
Break Even Point Sales ($)
Fixed Cost (A)	$180,000
Contribution Margin (B)	50%
Break Even Point Sales (A/B)	$360,000
3. Net Operating Income if sales increase by $41000
Revised Sales (A)	$2,041,000
Revised Variable Cost (B)	$1,020,500
Revised Contribution (C) (A-B)	$1,020,500
Fixed Cost (D)	$180,000
Net Operating Income (C-D)	$840,500
4 (a) Degree of Operating Leverage
Contribution (A)	$1,000,000
Net Operating Income (B)	$820,000
Degree of Operating Leverage (A/B)	1.22
4 (b) Percentage increase in net operating income
% Change in sales (A)	17%
Degree of operating leverage (B)	1.22
% change in operating income (A*B)	20.73%
5. If manager’s idea’s are implemented
Existing sales price	$80
Revised Sales price ($80 less 12% of $80)	$70.40
Existing Total Sales (A)	$2,000,000
Existing Sale Price (B)	$80
Existing Unit Sales (A/B)	25,000
Revised Unit Sales (25000 plus 25% of 25000)	31,250
5 (a) Revised Operating Income Statement
Sales Units (A)	31,250
Sales Price (B)	$70.40
Total Sales (C) (A*B)	$2,200,000
Variable Cost (31250*$40) (D)	$1,250,000
Contribution ( E) (C-D)	$950,000
Existing Fixed Cost (F)	$180,000
Additional Advertisement cost (G)	$74,000
Total Fixed Cost (H) (F+G)	$254,000
Revised Operating Income (E-H)	$696,000
5 (b) Increase in net operating income
Existing Operating Income	$820,000
Revised Operating Income	$696,000
Additional Income	-$124,000

Calculation of Revised per unit Contribution

Per Unit Contribution Margin
Revised Sales Price	$70.4
Variable Expenses	$40
Contribution Per unit	$30.4

Variable expense per unit will not increase or decrease as the question is silent on varable expense per unit.

Conclusion :- Since the net operating income will decline by $124,000, its not advisable to decrease the sales price.

6. Additional Advertisment Expense taht can be incurred to maintain same net operating income

Sale Price (A)	$80
Variable Cost (B)	$40
Additional Sales Commission ( C)	$1.60
Total Variable Cost (D) (B+C)	$41.60
Contribution (E ) (A-D)	$38.40
Revised Contribution Margin (E/A)	48%

Particulars	Per Unit	No of units	Total
Sales	$80	$31,250	$2,500,000
Variable Cost	$41.60	31250	$1,300,000
Contribution (i)	$38.40	31250	$1,200,000
Fixed Cost (ii)	-	-	$180,000
Required Net Operating Income (iii)	-	-	$820,000
Additional Advertisement Expense (i-ii-iii)	-	-	$200,000