Question

Bill and Co make jackets. The selling price is $80.

The jackets take 2 hours to make, labour is $10 an hour. They also require 4 square meters of cloth at $8 per square meter.  Fixed costs for the factory are $200,000  per year.

Solve in excel or anywhere you want, then copy-paste your answer to Canvas in text-form.

Required:

1. If they produce 10,000 jackets what will the profit be? (this is the base example)
2. How many pairs do Bill and co have to make to break even? How much is this in dollars?
3. What is the margin of safety in dollars and in percentage? What do you understand by margin of safety?
4. What is the operating leverage ratio of this company? Is that a good leverage?

Answer 1

Ans;

Selling Price : $80

Direct Material : 4 * $8 = $32

Direct Labor : 2 * $10 = $20

Contribution per unit : $80 - $32 - $20 = $28

Fixed Factory Overhead : $200,000

1.

Profit @ 10,000 Units:

Sale Price : 10,000 * $80 = $800,000

Varaible Costs : 10,000 * $52 = $520,000

Fixed Costs : $200,000

Profit : $800,000 - $520,000 - $200,000 = $80,000

2.

Break even Units : Fixed cost / Contribution per unit:

= $200,000 / $28 = 7,142.86 or 7,143 Units

Break even sales : 7,143 * $80 = $571,440

3.

Margin of Safety :

(Sales Unit - Break even point) / Current sales units

= (10,000 - 7,143) / 10,000 = 28.57%

Margin of Safety Dollars : Current sales Level * Margin of Safety * sales per unit

= 10,000 * 28.57% * $80 = $22,856

4.

Operating leverage: Contribution margin / Operating Income

Contribution margin = $800,000 - $520,000 = $280,000

Operating Income : $80,000

Operating Leverage : $280,000 / $80,000 = 3.5

*Company with high operating leverage means high fixed costs and less variable costs. So in such caseshigh operating leverage are good if sales are increasing over period.

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