Question

Question 1 Casas Modernas of Juarez, Mexico, is contemplating a major change in its cost structure. Currently, all of its drafting work is performed by skilled draftsmen. Rafael Jiminez, Casas’ owner, is considering replacing the draftsmen with a computerized drafting system. However, before making the change, Rafael would like to know the consequences of the change, since the volume of business varies significantly from year to year. Shown below are CVP income statements for each alternative. Manual System Computerized System Sales $1,780,000 $1,780,000 Variable costs 1,424,000 712,000 Contribution margin 356,000 1,068,000 Fixed costs 82,154 794,154 Net income $273,846 $273,846 Determine the degree of operating leverage for each alternative. (Round answers to 2 decimal places, e.g. 1.25.) Degree of Operating Leverage Manual System 1.3 Computerized System 3.9 LINK TO TEXT Calculate the increase in Net income for each alternative if sales increased by $110,000. Increase in Net Income Manual System Computerized System Which alternative would produce the higher net income ? LINK TO TEXT Calculate the margin of safety ratio. (Round ratios to 2 decimal places, e.g. 0.25.) Margin of Safety ratio Manual System Computerized System Using the margin of safety ratio, determine which alternative could sustain the greater decline in sales before operating at a loss.

Answer 1

Manual System Computerized System

Sales $1,780,000 $1,780,000

less: Variable costs 1,424,000 712,000

Contribution margin 356,000 1,068,000

Fixed costs 82,154 794,154

Net income $273,846 $273,846

1.   Manual System Computerized System

degree of operating leverage [Contribution margin / Net income]    356,000 / $273,846 1,068,000/ $273,846

=1.3 =3.9

2. Manual System Computerized System

degree of operating leverage   

[ change in net income / change in sale] 1.3 = change in net income 3.9 = change in net income 110000 increase in sale    110000 increase in sale    

   increase in net income = 143000 increase in net income =429000

Computerized System would produce the higher net income

3.   Margin of Safety ratio   Manual System Computerized System

[sales- break even sale] / sales   [$1,780,000 - 410770 ]/ 1780000    [$1,780,000 -1323590] / 1780000

=76.92% =25.64%

Note:-   Manual System Computerized System

Contribution margin ratio

[Contribution margin/ sales] 356,000 / $1,780,000   1,068,000 / $1,780,000

= 20% = 60%

Break even sale [fixed cost / contribution margin] 82,154 / 20%    794,154 / 60%

=410770 = 1323590

Manual System could sustain the greater decline in sales before operating at a loss, because of higher margin of safety ratio.