Question

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

Variable cost per rosette	$	1.20
Sales price per rosette		4.00
Total fixed costs per month		2800.00

Required:
1. Suppose Dana’s would like to generate a profit of $880. Determine how many rosettes it must sell to achieve this target profit. (Round your intermediate calculations to 2 decimal places and final answer tothe nearest whole number.)

	Target Units 1,314

2. If Dana’s sells 1,200 rosettes, compute its margin of safety in units, in sales dollars, and as a percentage of sales. (Round your Margin of Safety percentage to two decimal places (i.e. .1234 should be entered as 12.34%).

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

3. Calculate Dana’s degree of operating leverage if it sells 1,200 rosettes. (Round your intermediate calculations to 2 decimal places and final answer to 4 decimal places.)

	Degree of Operating Leverage

4. Using the degree of operating leverage, calculate the change in Dana’s profit if unit sales drop to 1,080 units. Confirm this by preparing a new contribution margin income statement. (Round your intermediate calculations to 4 decimal places and final answer to 2 decimal places. (i.e. .1234 should be entered as 12.34%.))

	Effect on Profit %

	Contribution Margin Income Statement For 1080 Rosettes Contribution Margin Income from Operations

Answer 1

Solution

Ribbon World

1. Desired units to earn target income:

Desired units = (fixed cost + target income)/contribution margin per unit

Contribution margin per unit = sales price per unit – variable cost per unit

Sales price per unit = $4

Variable cost per unit = $1.20

Contribution margin (CM) per unit = $2.80

Fixed cost per month = $2,800

Target income = $880

Number of rosettes to sell =($2,800 +$880)/$2.80 = 1,314 rosettes (rounded to nearest whole number)

1. Margin of safety in units , sales dollars and as %:

Margin of safety = actual sales – break-even sales

Actual sales = $4 x 1,200 rosettes = $4,800

Break-even sales = fixed cost/CM ratio

CM ratio = (CM/Sales) x 100

= (2.8/4) x 100 = 70%

Break-even sales in dollars = 2,800/70% = $4,000

Margin of safety in dollars = $4,800 - $4,000 = $800

MOS in units = $800/$4 = 200 rosettes

Margin of safety as % = MOS Sales/actual sales x 100

MOS as a % =800/4,800 = 16.67%

1. Degree of operating leverage:

Degree of operating leverage = CM/Net Income

Sales = $4 x 1,200 = $4,800

Contribution margin = $2.80 x 1.200 = $3,360

Less: Fixed cost = $2,800

Net Income = $560

Degree of operating leverage = 3,360/560 =6

1. Effect on profit – when sales drop to 1,080 units

Effect on profit = % change in sales x degree of operating leverage

Percentage change in sales = (1,200 -1,080)/1,200 = 10%

Sales decreased by 10%

Change in profit = -10% x 6 = 60%

Hence, profits decrease by 60% when sales drop by 10% to reach 1,080.

1. For 1,080 rosettes sold -

Contribution margin income statement for 1,080 rosettes
	Sales	$4,320
	Variable cost	$1,296
	CM	$3,024
	Fixed cost	$2,800
	Net Income	$224

Net income at 1,200 rosettes sales = $560
decrease in net income = 560 – 224 = 336

Percentage decrease in net income = 336/560 = 60%

Hence, profits fall by 60% when sales drop by 10%