Question

Josh Reddick Inc. makes and sells a computer game which has the following data:

Unit sales price                                     $60

Unit variable manufacturing cost           $16

Annual fixed, selling and

   administrative costs                            $56,000

Unit variable selling costs                      $14

Annual fixed manufacturing cost (with respect to sales volume):

Depreciation                                         $55,710

Setups (46 @ $80 each)                         $ 3,680

Inspections (1,210 @ $9 each)               $10,890

Material handling

   (1,480 hours @ $14 per hour)             $20,720

The management of Reddick is considering the installation of a new computer-controlled equipment that will streamline the production process and generate output of higher quality than the present production system. With the new equipment there will be an increase in fixed costs with respect to sales volume. The new data, if the system is implemented will be as follows:

Unit sales price                                     $60

Unit variable manufacturing cost           $11

Annual fixed, selling and

   administrative costs                            $52,000

Unit variable selling costs                      $14

Annual fixed manufacturing cost (with respect to sales volume):

Depreciation                                         $138,050

Setups (420 @ $35 each)                       $ 14,700

Inspections (420 @ $5 each)                  $    2,100

Material handling

   (210 hours @ $15 per hour)                $    3,150

REQUIRED: Based on the above information, compute the break-even point in annual sales units under the present production system, and break-even point using the new production system.

Assume Reddick’s sales of 10,000 units, what is their current operating leverage and what would be their new operating leverage?

Answer 1

A	B	C	D	E	F	G	H	I
2
3		Breakeven units are number of units that company needs to produce to cover its fixed and variable costs.
4		Contribution margin per unit is Unit price of the product less the unit variable costs.
5
6		Breakeven units can be calculated using the following formula:
7
8
9
10
11		Calculation of breakeven units for present production system:
12
13		Total Variable costs can be calculated as follows:
14		Variable manufacturing cost	$16
15		Variable selling costs	$14
16		Total variable cost per unit	$30
17
18		Total Fixed Cost can be calculated as follows:
19		Fixed selling and administrative costs	$56,000
20		Depreciation	$55,710
21		Setups	$3,680
22		Inspections	$10,890
23		Materials Handling	$20,720
24		Total Fixed cost	$147,000
25
26		Contribution margin can be calculated as follows:
27		Contribution margin Per unit	= Selling Price per unit- Variable cost per unit
28		Using the following data:
29		Selling Price Per unit	$60.00
30		Total variable cost per unit	$30.00
31
32		Contribution margin Per unit	= Selling Price per unit- Variable cost per unit
33			$30.00
34
35		Using the folling data:
36		Contribution margin per unit	$30
37		Fixed Cost	$147,000
38
39		Breakeven Units	=Fixed Costs / Contribution margin per unit
40			4,900.00
41
42		Hence breakeven-units for present system is	4,900.00
43
44
45		Calculation of breakeven units for present production system:
46
47		Total Variable costs can be calculated as follows:
48		Variable manufacturing cost	$11
49		Variable selling costs	$14
50		Total variable cost per unit	$25
51
52		Total Fixed Cost can be calculated as follows:
53		Fixed selling and administrative costs	$52,000
54		Depreciation	$138,050
55		Setups	$14,700
56		Inspections	$2,100
57		Materials Handling	$3,150
58		Total Fixed cost	$210,000
59
60		Contribution margin can be calculated as follows:
61		Contribution margin Per unit	= Selling Price per unit- Variable cost per unit
62		Using the following data:
63		Selling Price Per unit	$60.00
64		Total variable cost per unit	$25.00
65
66		Contribution margin Per unit	= Selling Price per unit- Variable cost per unit
67			$35.00
68
69		Using the folling data:
70		Contribution margin per unit	$35
71		Fixed Cost	$210,000
72
73		Breakeven Units	=Fixed Costs / Contribution margin per unit
74			6,000.00	=D71/D70
75
76		Hence breakeven-units for New production system is	6,000.00
77
78
79		Calculation of current operating leverage:
80		Degree of operating leverage (DOL) can be calculated using following formula:
81		DOL	=Contribution margin ratio / Operating margin
82
83		Operating margin	=Operating income / Sales
84
85		Using following data
86		Number of units sold	10000
87		Selling Price	$60
88		Total Variable cost per unit	$30
89		Total Fixed cost	$147,000
90
91		Sales	$600,000
92		Operating income	$153,000
93
94		Operating margin	=Operating income / Sales
95			25.50%	=D92/D91
96
97
98		Contribution margin ratio	=Contribution margin per unit / Selling Price per unit
99			0.50	=D33/D29
100
101		Now Degree of operating leverage (DOL) can be calculated using following formula:
102		DOL	=Contribution margin ratio / Operating margin
103
104		Using the following data
105		Contribution margin ratio	50%
106		Operating margin	25.50%
107
108		DOL	=Contribution margin ratio / Operating margin
109			1.96
110
111		Hence current degree of operating leverage is	1.96
112
113
114		Calculation of new operating leverage:
115		Degree of operating leverage (DOL) can be calculated using following formula:
116		DOL	=Contribution margin ratio / Operating margin
117
118		Operating margin	=Operating income / Sales
119
120		Using following data
121		Number of units sold	10000
122		Selling Price	$60
123		Total Variable cost per unit	$25
124		Total Fixed cost	$210,000
125
126		Sales	$600,000
127		Operating income	$140,000
128
129		Operating margin	=Operating income / Sales
130			23.33%	=D127/D126
131
132
133		Contribution margin ratio	=Contribution margin per unit / Selling Price per unit
134			0.58	=(D122-D123)/D122
135
136		Now Degree of operating leverage (DOL) can be calculated using following formula:
137		DOL	=Contribution margin ratio / Operating margin
138
139		Using the following data
140		Contribution margin ratio	58%
141		Operating margin	23.33%
142
143		DOL	=Contribution margin ratio / Operating margin
144			2.50	=D140/D141
145
146		Hence new degree of operating leverage is	2.50
147

Formula sheet

A	B	C	D	E	F	G	H	I
2
3		Breakeven units are number of units that company needs to produce to cover its fixed and variable costs.
4		Contribution margin per unit is Unit price of the product less the unit variable costs.
5
6		Breakeven units can be calculated using the following formula:
7
8
9
10
11		Calculation of breakeven units for present production system:
12
13		Total Variable costs can be calculated as follows:
14		Variable manufacturing cost	16
15		Variable selling costs	14
16		Total variable cost per unit	=SUM(D14:D15)
17
18		Total Fixed Cost can be calculated as follows:
19		Fixed selling and administrative costs	56000
20		Depreciation	55710
21		Setups	3680
22		Inspections	10890
23		Materials Handling	20720
24		Total Fixed cost	=SUM(D19:D23)
25
26		Contribution margin can be calculated as follows:
27		Contribution margin Per unit	= Selling Price per unit- Variable cost per unit
28		Using the following data:
29		Selling Price Per unit	60
30		Total variable cost per unit	=D16
31
32		Contribution margin Per unit	= Selling Price per unit- Variable cost per unit
33			=D29-D30
34
35		Using the folling data:
36		Contribution margin per unit	=D33
37		Fixed Cost	=D24
38
39		Breakeven Units	=Fixed Costs / Contribution margin per unit
40			=D37/D36
41
42		Hence breakeven-units for present system is	=ROUND(D40,0)
43
44
45		Calculation of breakeven units for present production system:
46
47		Total Variable costs can be calculated as follows:
48		Variable manufacturing cost	11
49		Variable selling costs	14
50		Total variable cost per unit	=SUM(D48:D49)
51
52		Total Fixed Cost can be calculated as follows:
53		Fixed selling and administrative costs	52000
54		Depreciation	138050
55		Setups	14700
56		Inspections	2100
57		Materials Handling	3150
58		Total Fixed cost	=SUM(D53:D57)
59
60		Contribution margin can be calculated as follows:
61		Contribution margin Per unit	= Selling Price per unit- Variable cost per unit
62		Using the following data:
63		Selling Price Per unit	60
64		Total variable cost per unit	=D50
65
66		Contribution margin Per unit	= Selling Price per unit- Variable cost per unit
67			=D63-D64
68
69		Using the folling data:
70		Contribution margin per unit	=D67
71		Fixed Cost	=D58
72
73		Breakeven Units	=Fixed Costs / Contribution margin per unit
74			=D71/D70	=D71/D70
75
76		Hence breakeven-units for New production system is	=ROUND(D74,0)
77
78
79		Calculation of current operating leverage:
80		Degree of operating leverage (DOL) can be calculated using following formula:
81		DOL	=Contribution margin ratio / Operating margin
82
83		Operating margin	=Operating income / Sales
84
85		Using following data
86		Number of units sold	10000
87		Selling Price	60
88		Total Variable cost per unit	=D16
89		Total Fixed cost	=D24
90
91		Sales	=D86*D87
92		Operating income	=D91-D86*D88-D89
93
94		Operating margin	=Operating income / Sales
95			=D92/D91	=D92/D91
96
97
98		Contribution margin ratio	=Contribution margin per unit / Selling Price per unit
99			=D33/D29	=D33/D29
100
101		Now Degree of operating leverage (DOL) can be calculated using following formula:
102		DOL	=Contribution margin ratio / Operating margin
103
104		Using the following data
105		Contribution margin ratio	=D99
106		Operating margin	=D95
107
108		DOL	=Contribution margin ratio / Operating margin
109			=D105/D106
110
111		Hence current degree of operating leverage is	=D109
112
113
114		Calculation of new operating leverage:
115		Degree of operating leverage (DOL) can be calculated using following formula:
116		DOL	=Contribution margin ratio / Operating margin
117
118		Operating margin	=Operating income / Sales
119
120		Using following data
121		Number of units sold	10000
122		Selling Price	60
123		Total Variable cost per unit	=D64
124		Total Fixed cost	=D58
125
126		Sales	=D121*D122
127		Operating income	=D126-D121*D123-D124
128
129		Operating margin	=Operating income / Sales
130			=D127/D126	=D127/D126
131
132
133		Contribution margin ratio	=Contribution margin per unit / Selling Price per unit
134			=(D122-D123)/D122	=(D122-D123)/D122
135
136		Now Degree of operating leverage (DOL) can be calculated using following formula:
137		DOL	=Contribution margin ratio / Operating margin
138
139		Using the following data
140		Contribution margin ratio	=D134
141		Operating margin	=D130
142
143		DOL	=Contribution margin ratio / Operating margin
144			=D140/D141	=D140/D141
145
146		Hence new degree of operating leverage is	=D144
147