Question

Fraser Co. is considering a change to its cost structure. Below is the data relating to the current structure as well as the proposed change.

Current Structure

Proposed Structure

Unit Sales

20,000

Unit Sales

20,000

Sales Price Per Unit

$100

Sales Price Per Unit

$100

Total Variable Costs (based on 20,000 units)

$400,000

Total Variable Costs (based on 20,000 units)

$700,000

Total Fixed Costs

$900,000

Total Fixed Costs

$600,000

1.) Prepare a CVP Statement for each cost structure. Incorporate cell references and formulas where indicated. You can instantly create the CVP Statement for the Proposed Structure, by copying and pasting your completed CVP Statement for the Current Structure. Make sure all highlighted areas are completed. Try to avoid the headings when copying. You want to keep the Proposed Structure heading.

CVP Statement - Current Structure

CVP Statement - Proposed Structure

% of Sales

Total

Per Unit

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2.) Use the Contribution Margin technique to calculate the Breakeven point in units and dollars for each scenario. You can save time again by copying from one section to the next. Be careful with the headings.

Breakeven Units - Current Structure

Breakeven Units - Proposed Structure

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Breakeven Sales Dollars - Current Structure

Breakeven Sales Dollars - Proposed Structure

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3.) Compare the Net Operating Income and Breakeven calculations for both scenarios. What happened to the breakeven point and why?

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4.) Compute the Degree of Operating Leverage for both scenarios. Save time again.

Degree of Operating Leverage - Current Structure

Degree of Operating Leverage - Proposed Structure

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5.) Use the Degree of Operating Leverage to determine how a 10% increase in sales will impact Net Income.

Current

Proposal

Degree of Operating Leverage

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Number

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Net Income Impact

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Old Net Income

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New Net Income

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6.) Save and print (face -to-face class )

7.) Copy ROWS 1-17 of this spreadsheet tab ("ORIGINAL") to the "Revisions" tab .

8.) Use the "Revision" spreadsheet to prove your calculation from instruction #5 of the "Original" spreadsheet by increasing the sales volume in the data section (gray shaded area) by 10%. Remember to change anything else in the data section which would be affected by a change in sales volume. You should not make any changes below row 6.

Answer 1

Since, there are multiple parts to the question, I have answered the first four.

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Part 1)

The CVP structure is given as below:

CVP Statement - Current Structure
	Total	Per Unit	Percentage
Sales	2,000,000	100	100%
Variable Costs	400,000	20	20%
Contribution Margin	1,600,000	80	80%
Fixed Costs	900,000
Net Operating Income	$700,000

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CVP Statement - Proposed Structure
	Total	Per Unit	Percentage
Sales	2,000,000	100	100%
Variable Costs	700,000	35	35%
Contribution Margin	1,300,000	65	65%
Fixed Costs	600,000
Net Operating Income	$700,000

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Part 2)

The breakeven point in units and dollars under each structure can be calculated with the use of formulas given below:

Breakeven Point (in Units) = Fixed Cost/Contribution Margin Per Unit

Breakeven Point (in Dollars) = Fixed Cost/Contribution Margin Percentage

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Substituting values in the above formula, we get,

Current Structure

Breakeven Point (in Units) = 900,000/80 = 11,250 units

Breakeven Point (in Dollars) = 900,000/80% = $1,125,000

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Proposed Structure

Breakeven Point (in Units) = 600,000/65 = 9,230.77 units or 9,231 units

Breakeven Point (in Dollars) = 600,000/65% = $923,076.92 or $923,077

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Part 3)

Based on the calculations made in Part 1) and Part 2), we can observe that the net operating income has remained constant at $700,000 under both the current and proposed structure. However, the breakeven point in both units and dollars has declined under the proposed structure. It is because of the reduction in the value of fixed costs from $900,000 to $600,000 which is proportionately more than the increase in variable cost per unit.

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Part 4)

The degree of operating leverage can be calculated with the use of following formula:

Degree of Operating Leverage = Contribution Margin/Net Operating Income

Using the values calculated in Part 1), we get,

Degree of Operating Leverage (Current Structure) = 1,600,000/700,000 = 2.29

Degree of Operating Leverage (Proposed Structure) = 1,300,000/700,000 = 1.86