Question

Klein Company distributes a high-quality bird feeder that sells for $40 per unit. Variable costs are $14 per unit, and fixed costs total $182,000 annually.

Required:

Answer the following independent questions:

1. What is the product’s CM ratio?

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

3. The company estimates that sales will increase by $68,000 during the coming year due to increased demand. By how much should operating income increase?

4. Assume that the operating results for last year were as follows:

Sales	$	800,000
Variable expenses		527,000
Contribution margin		273,000
Fixed expenses		182,000
Operating income	$	91,000

a. Compute the degree of operating leverage at the current level of sales.

b. The president expects sales to increase by 17% next year. By how much should operating income increase?

Answer 1

Contribution Margin is Selling Price Per unit less Variable Cost per unit

Hence in this case Contribution Margin = 40$ - 14$ = 26$ =

Answer to subpart 1 = Contribution ratio = Contribution / Sales price per unit

= 26/40 = 65%

Answer to subpart 2 = Now fixed cost = 182,000$

therefore break even unit = Fixed Cost / Contribution Margin

= 182000 / 26

= 7000 units

Answer to subpart 3

Sales will increase by $ 68000 . So number of units which will be sold extra = Sales / Selling price per unit

= 68000 / 40

= 1700 units

Now additional 1700 units will be sold which will give us 1700 * 26 ( Contribution margin ) = $ 44200 additional operating Income.

This could have been also calculated by multiplying $ 68000 with contribution ratio which is 65% .

Answer to subpart 4

part a Operating leverage = Contribution / Operating Income

= 273000 / 91000

= 3

part b Sales are expected to increase by 17%. We can diretly calculate operating income with help of operating levereage. Operating income change = change in sales x operatig leverage ratio

= 17% * 3 = 51%

Therefore operating income will rise by 51 % i.e. from 91000 $ to 137410 $