Question

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $80 per unit. Variable expenses are $40.00 per unit, and fixed expenses total $180,000 per year. Its operating results for last year were as follows:

Sales	$	2,080,000
Variable expenses		1,040,000
Contribution margin		1,040,000
Fixed expenses		180,000
Net operating income	$	860,000

Required:

Answer each question independently based on the original data:

1. What is the product's CM ratio?

2. Use the CM ratio to determine the break-even point in dollar sales.

3. If this year's sales increase by $56,000 and fixed expenses do not change, how much will net operating income increase?

4-a. What is the degree of operating leverage based on last year's sales?

4-b. Assume the president expects this year's sales to increase by 14%. Using the degree of operating leverage from last year, what percentage increase in net operating income will the company realize this year?

5. The sales manager is convinced that a 11% reduction in the selling price, combined with a $63,000 increase in advertising, would increase this year's unit sales by 25%.

a. If the sales manager is right, what would be this year's net operating income if his ideas are implemented?

b. If the sales manager's ideas are implemented, how much will net operating income increase or decrease over last year?

6. The president does not want to change the selling price. Instead, he wants to increase the sales commission by $2.40 per unit. He thinks that this move, combined with some increase in advertising, would increase this year's sales by 25%. How much could the president increase this year's advertising expense and still earn the same $860,000 net operating income as last year?

Answer 1

1. contribution margin Ratio = contribution margin / sales

                                                                = $1,040,000 / $2,080,000

                                                                = 50%

2. Break in point in dollar sales = Fixed cost / contribution margin ratio

                                                                = $180,000 / 50%

                `                                               = $360000

3. Increase in net operating income = $56,000 x 50%

                                                        = $28000

4a. Degree of operating leverage = Contribution margin / Operating income

                                                                = $1,040,000 / $860,000

                                                                = 1.21

4b. increase in operating income = 14% x 1.21

                                                                = 16.94%

Therefore increase in operating income = $860,000 x 16.94%

                                                               = $145684(difference due to approximation of leverage)

or $145,600

5. New selling price = $80 x 89% = $71.2

   New sale units = 26,000 + 25% = 32500units

    New fixed expenses = $180,000 + $63,000 = $243,000

Sales	$2,314,000
variable expenses	$1,300,000
contribution marign	$1,014,000
Fixed expenses	$243,000
Net operating income	$771,000

     

   

Net operating income = $771,000

b. Decrease in operating income = $860,000 - $771,000 = $ 89000

6. New variable cost = $40 + $2.40 = $42.40

   New sale units = 32,500

Sales	$2,600,000
variable expenses	$1,378,000
contribution marign	$1,222,000
Fixed expenses	$243,000
Net operating income	$979,000

  

Maximum advertising expenses = Net operating income – Desired operating income

                                                                                = $979,000 - $860,000

                                                                                = $119000