Question

Cove’s Cakes is a local bakery. Price and cost information follows:

Price per cake	$	13.71
Variable cost per cake
Ingredients		2.16
Direct labor		1.15
Overhead (box, etc.)		0.15
Fixed cost per month	$	4,715.00

Required:

1. Calculate Cove’s new break-even point under each of the following independent scenarios:

a. Sales price increases by $1.80 per cake.

b. Fixed costs increase by $530 per month.

c. Variable costs decrease by $0.34 per cake.

d. Sales price decreases by $0.60 per cake.

2. Assume that Cove sold 475 cakes last month. Calculate the company’s degree of operating leverage.

3. Using the degree of operating leverage, calculate the change in profit caused by a 5 percent increase in sales revenue.

Answer 1

Solution: 1 Calculate Cove’s new break-even point

Break Even point (Unit) = Fixed Cost / Contribution Per unit

Scenario a)  Sales price increases by $1.80 per cake

Scenario b) Fixed costs increase by $530 per month

Scenario c) Variable costs decrease by $0.34 per cake

Scenario d)  Sales price decreases by $0.60 per cake

Solution: 2 Calculation of the company’s degree of operating leverage

Degree of Operating Leverage = Contribution Margin / Net Profit

= $4868.75 / 153.75

= 31.6666 times

Solution: 3  Using the degree of operating leverage, calculate the change in profit caused by a 5 percent increase in sales revenue

Change in Profit = Net Income * Expected increase in Net Income

Here,

Net Income = 153.75

Expected Increase in Net income = Degree of Operating leverage * expected change in sales

= 31.6666 * 5%

= 158.35%

Now, substituting these figures into above formula,

Change in Profit = $153.75 * 158.33%

= $243.44