Question

Magic Realm, Inc., has developed a new fantasy board game. The company sold 15,000 games last year at a selling price of $20 per game. Fixed expenses associated with the game total $182,000 per year, and variable expenses are $6 per game. Production of the game is entrusted to a printing contractor. Variable expenses consist mostly of payments to this contractor.

Required:

1-a. Prepare a contribution format income statement for the game last year.

1-b. Compute the degree of operating leverage.

2. Management is confident that the company can sell 18,000 games next year (an increase of 3,000 games, or 20%, over last year). Given this assumption:

a. What is the expected percentage increase in net operating income for next year?

b. What is the expected amount of net operating income for next year? (Do not prepare an income statement; use the degree of operating leverage to compute your answer.)

Answer 1

Answer to 1-a :

Contribution Format Income Statement

Particulars

Amount ($)

Sales

3,00,000

Less : Variable Costs

90,000

Contribution Margin

2,10,000

Less : Fixed Costs

1,82,000

Operating Income

28,000

Answer to 1-b :

Degree of Operating Leverage = Contribution Margin/Operating Income = 210,000/28,000 = 7.5 times

Answer to 2-a :

Sales of 18,000 games next year represents a 20% increase in sales and since the degree of operating leverage is 7.5, Operating income should increase by 150% (7.5*20)

Answer to 2-b :

Particulars

Amount ($)

Last year's operating income

28,000

Expected increase - 150%*28,000

42,000

Total expected operating income

70,000