Question

In: Accounting

Magic Realm, Inc., has developed a new fantasy board game. The company sold 24,600 games last...

Magic Realm, Inc., has developed a new fantasy board game. The company sold 24,600 games last year at a selling price of $68 per game. Fixed expenses associated with the game total $410,000 per year, and variable expenses are $48 per game. Production of the game is entrusted to a printing contractor. Variable expenses consist mostly of payments to this contractor.

Required:

1-a. Prepare a contribution format income statement for the game last year.

1-b. Compute the degree of operating leverage.

2. Management is confident that the company can sell 31,488 games next year (an increase of 6,888 games, or 28%, over last year). Given this assumption:

a. What is the expected percentage increase in net operating income for next year?

b. What is the expected amount of net operating income for next year? (Do not prepare an income statement; use the degree of operating leverage to compute your answer.)

Solutions

Expert Solution

1-a

Contribution margin format income statement -

Amount
Sales (24600×$68) $1672800
Less: Variable cost (24600×$48) ($1180800)
Contribution margin $492000
Less: Fixed cost ($410000)
Operating income $82000

1-b Degree of operating leverage = 6

Solution :

Degree of Operating leverage = Contribution margin /operating income

= $492000/$82000

= 6

2-a Percentage increase in operating income = 168%

Solution :

Operating leverage means that if sales changes by 1% then operating income changes by 6%

Therefore

If 1% = 28%

Then 6% = ?

Percentage increase in sales = (28×6)/1 = 168%

OR

degree of operating leverage = percentage change in operating income / percentage change in sales

6 = percentage change in operating income /28

Percentage change in operating income = 6×28

= 168

That means 168%

2-b Operating income = $219760

Solution :

Increased operating income = previous year operating income + percentage increase in operating income

= $82000+168%

= $219760


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