Question

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $40 per unit. Variable expenses are $20.00 per unit, and fixed expenses total $200,000 per year. Its operating results for last year were as follows:

Sales	$	1,000,000
Variable expenses		500,000
Contribution margin		500,000
Fixed expenses		200,000
Net operating income	$	300,000

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 54,000 units and $2,160,000, 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 15%. 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 14% reduction in the selling price, combined with a $67,000 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 $2.20 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 $300,000 net operating income as last year?

Answer 1

Sales ( 25000 *40)	$	1,000,000
Variable expenses (25000*20)		500,000
Contribution margin		500,000
Fixed expenses		200,000
Net operating income	$	300,000

1. Contribution Margin Ratio = Contribution/sales *100

                                                    = 500000/1000000*100

                                                    = 50%

2. Break even point = Fixed cost/CM Ratio

                                  = 200000/50%

                                  = $400000

3.

Sales ( 79000 *40)	$	3160000
Variable expenses (79000*20)		1580000
Contribution margin		1580000
Fixed expenses		200,000
Net operating income	$	1380000

Increase in net operating income       1080000

4. (a) Operating leverage = Contribution/Profits

                                            = 500000/300000

                                            =1.67

(b) Degree of operating leverage = %change in EBIT/%change in Sales

                                               1.67 = %change in EBIT/15

                                                 %change in EBIT = 25%

5 (a)

Sales ( 25000+25% of 25000) *40- 14% of 40)		1075000
Variable expenses (31250*20)		625000
Contribution margin		450000
Fixed expenses (200000+67000)		267000
Net operating income		183000

(b) Increase/(decrease) in operating expenses = (183000-300000)/300000*100

                                                                        = (39%)

6. Let us assume advertisement is x.

Sales ( 25000+25% of 25000) *40)		1250000
Variable expenses (31250*20)		625000
Contribution margin		625000
Fixed expenses (200000+2.20*31250+x)		268750+x
Net operating income		356250-x

Net operating income (Given)                               300000

Advertisement Expense                                             =356250-300000

                                                                                     =56250