Question

Magic Realm, Inc., has developed a new fantasy board game. The company sold 35,600 games last year at a selling price of $62 per game. Fixed expenses associated with the game total $623,000 per year, and variable expenses are $42 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 42,720 games next year (an increase of 7,120 games, or 20%, 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.)

Answer 1

• All working forms part of the answer
• Requirement 1A

A = 35600 x 62	Sales revenue	$      2,207,200.00
B = 35600 x 42	Variable Expenses	$      1,495,200.00
C = A - B	Contribution margin	$          712,000.00
D	Fixed Expenses	$          623,000.00
E = C - D	Net Operating Income	$            89,000.00

• Requirement 1B

A	Contribution margin	$          712,000.00
B	Net Operating Income	$            89,000.00
C= A/B	Degree of Operating Leverage	8

• Requirement 2A

A	% Increase in Sale	20%
B	Degree of Operating Leverage	8
C = A x B	Expected % increase in Net Operating Income	160%

• Requirement 2B

A	Current Net Operating Income	$            89,000.00
B	Expected % increase in Net Operating Income (computed using degree of operating leverage above)	160%
C = A x B	Increase in Net Operating Income next year	$          142,400.00
D = A+C	Expected amount of net Operating income for next year	$          231,400.00