Question

Degree of Operating Leverage, Percent Change in Profit Ringsmith Company is considering two different processes to make its product—process 1 and process 2. Process 1 requires Ringsmith to manufacture subcomponents of the product in-house. As a result, materials are less expensive, but fixed overhead is higher. Process 2 involves purchasing all subcomponents from outside suppliers. The direct materials costs are higher, but fixed factory overhead is considerably lower. Relevant data for a sales level of 31,000 units follow:     Process 1     Process 2 Sales     $7,750,000     $7,750,000 Varoable expenses     2,790,000     4,402,000      Contribution margin     $4,960,000     $3,348,000 Less total fixed expenses     3,531,590     1,455,400      Operating income     $1,428,410     $1,892,600 Unit selling price     $250     $250 Unit variable cost     $90     $142 Unit contribution margin     $160     $108 Required: 1. Compute the degree of operating leverage for each process. Round your answers to one decimal place. Use the rounded answers in subsequent calculations. Process 1 Process 2 2. Suppose that sales are 20 percent higher than budgeted. By what percentage will operating income increase for each process? Process 1 % Process 2 % What will be the increase in operating income for each system? Round your answers to the nearest dollar. Process 1 $ Process 2 $ What will be the total operating income for each process? Round your intermediate calculations and final answers to the nearest dollar. Use the rounded answers in subsequent calculations. Process 1 $ Process 2 $ 3. What if unit sales are 10 percent lower than budgeted? By what percentage will operating income decrease for each process? Process 1 % Process 2 % What will be the total operating income for each process? Round your answers to the nearest dollar. Process 1 $ Process 2 $

Answer 1

1. Compute the degree of operating leverage for each process. Round your answers to one decimal place. Use the rounded answers in subsequent calculations.

Process 1	4960000/1428410 = 3.5
Process 2	3348000/1892600 = 1.8

2. Suppose that sales are 20 percent higher than budgeted. By what percentage will operating income increase for each process?

Process 1	20*3.5 = 70	%
Process 2	20*1.8 = 36	%

What will be the increase in operating income for each system? Round your answers to the nearest dollar.

Process 1	$1428410*70% = 999887
Process 2	$1892600*36% = 681336

What will be the total operating income for each process? Round your intermediate calculations and final answers to the nearest dollar. Use the rounded answers in subsequent calculations.

Process 1	$1428410+999887 = 2428297
Process 2	$1892600+681336 = 2573936

3. What if unit sales are 10 percent lower than budgeted? By what percentage will operating income decrease for each process?

Process 1		3.5*10 = 35%
Process 2		1.8*10 = 18%

What will be the total operating income for each process? Round your answers to the nearest dollar.

Process 1	$1428410*65% = 928467
Process 2	$1892600*82% = 1551932