Question

Dana’s Ribbon World makes award rosettes. Following is information about the company:

Variable cost per rosette	$	1.20
Sales price per rosette		5.00
Total fixed costs per month		3800.00

Required:

1. Suppose Dana’s would like to generate a profit of $1,020. Determine how many rosettes it must sell to achieve this target profit.

Target Units

2. If Dana’s sells 1,520 rosettes, compute its margin of safety in units, in sales dollars, and as a percentage of sales.

	Margin of Safety (Units) Rosettes Margin of Safety in Dollars Percentage of Sales %

3. Calculate Dana’s degree of operating leverage if it sells 1,520 rosettes.

	Degree of Operating Leverage

4a. Using the degree of operating leverage, calculate the change in Dana’s profit if unit sales drop to 1,140 units.

	Degree of Operating Leverage

4b. Prepare a new contribution margin income statement to verify change in dana's profit.

Contribution Margin Income Statement
For 1,140 Rosettes
Contribution Margin
Income from Operations

Answer 1

1. Suppose Dana’s would like to generate a profit of $1,020. Determine how many rosettes it must sell to achieve this target profit.

Target profit = $1020

[(Selling price – Variable cost) * Units sold] – Fixed cost = Target profit

[($5 - $1.2) * Units sold] - $3800 = $1020

Units sold = 1268 units

2. If Dana’s sells 1,520 rosettes, compute its margin of safety in units, in sales dollars, and as a percentage of sales.

Margin of safety in units = Actual sales in units – BEP in units

BEP in units = Fixed cost/Contribution per unit

Contribution per unit = $5 - $1.2 = $3.80

   = $3800/$3.80 = 1000 units

Margin of safety = 1520 – 1000 = 520 units

Margin of safety in dollars = Margin of safety in units * SP

    = 520 units * $5 = $2600

Percentage of sales = Margin of safety in dollars/Sales

Sales = 1520 * $5 = $7600

$2600/$7600 = 34.21%

3. Calculate Dana’s degree of operating leverage if it sells 1,520 rosettes.

Degree of operating leverage = Contribution/Net operating income

Contribution = 1520 units * $3.8 = $5776

Net operating income = Contribution – Fixed cost

    = $5776 - $3800 = $1976

DOL = $5776/$1976 = 2.92

4a. Using the degree of operating leverage, calculate the change in Dana’s profit if unit sales drop to 1,140 units.

Decrease in units = 1520 – 1140 = 380 units

Percentage decrease = 380/1520 = 25%

Decrease in profit percentage= 25% * 2.92 = 73%

Change in profit = $1976 * 73% = $1443

4b. Prepare a new contribution margin income statement to verify change in dana's profit.

Sales (1140 * $5)	$5700
Less: Variable cost (1140 * $1.2)	$1368
Contribution margin	$4332
Less: Fixed cost	$3800
Income from operations	$532