Question

Mustang Ltd. processes cow skins into leather soles for shoes. The unit selling price is $32, the unit variable cost is $24, and fixed costs are $320,000.

Required:

1. Calculate the break-even point in number of units.
2. Calculate the break-even point in sales dollars.
3. How many sales, in units, would be required to earn an operating profit of $40,000?

For parts d, e, and f, assume Mustang is able to reduce its variable costs by $3 per unit.

1. What is the new contribution margin per unit?
2. What is the new break-even point?
3. We are still experiencing the lower variable costs from parts d and e. Mustang executives believe that if they lowered the selling price by 10%, they would sell 20% more units. What sales dollar figure would now be required to earn an operating profit of $60,000?
4. At an operating profit of $40,000 and costs as per the initial data, what is the degree of operating leverage? Show your calculations.

Answer 1

a.

Break even points in units = Fixed costs / Contribution margin per unit

Contribution margin per unit = Selling price - Variable cost

= $32 - $24

= $8

Break even points in units = $320,000 / $8

= 40,000 units

b.

Break even points in sales dollars = Break even points in units * Selling price

= 40,000 * $32

= $1,280,000

c.

Units needs to sell = (Fixed costs + Operating profit) / Contribution margin per unit

= ($320,000 + $40,000) / $8

= 45,000 units

If variable cost per unit reduce by $3, new variable cost per unit $21 ($24 - $3).

d.

New contribution margin per unit = Selling Price - Variable cost per unit

= $32 - $21

= $11

e.

New break even point = Fixed costs / Contribution margin per unit

= $320,000 / $11

= 29,091 units

f.

New selling price = $32 * 0.90

= $28.80

New contribution margin per unit = Selling price - Variable cost per unit

= $28.80 - $21

= $7.80

Required Sales dollars = [(Fixed costs + Operating profit) / Contribution margin per unit] * Selling price

= [($320,000 + $60,000) / $7.80] * $28.80

= 48,718 units * $28.80

= $1,403,078

g.

Degree of operating leverage = Contribution margin / Operating income

Contribution margin = Fixed costs + Operating profit

= $320,000 + $40,000

= $360,000

Degree of operating leverage = $360,000 / $40,000

= 9