Question

ABC Corporation has provided the following contribution format income statement. All questions concern situations that are within the relevant range. Show your calculations

Sales (6,000 units) $300,000

Variable expenses 240,000

Contribution margin 60,000

Fixed expenses 58,800

Net operating income $1,200

a. What is the contribution margin ratio? What does it mean?

b. If sales increase to 6,040 units, what would be the estimated increase in net operating income?

c. If the selling price increases by $4 per unit and the sales volume decreases by 200 units, what would be the estimated net operating income? Would you recommend this scenario? Why?

d. What is the break-even point in units and in dollars?

e. What is the margin of safety in units?

f. What is the degree of operating leverage? If the ABC Corporation plans to increase its sales by 10%, what would be the estimated net operating income? (Use the concept of degree of operating leverage to estimate the net operating income)?

g. Estimate how many units must be sold to achieve a target profit of $26,100.

Answer 1

1. Contribution margin ratio = ( $ 60,000 * 100 ) / $ 300,000

1. Contribution margin ratio = 20 %

>> Contribution margin ratio is an amount of margin in sales for every one dollar of sales.

2. Selling price = $ 300,000 / 6,000

2. Selling price = $ 50.

>> Increase in Net operating income = 6,040 * $ 50 * 20 %

>> Increase in Net operating income = $ 60,400.

3. New selling price = $ 50 + $ 4

3. New selling price = $ 54.

>> Sales volume = 6,000 - 200

>> Sales volume = 5,800.

>> Variable cost = $ 240,000 / 6,000

>> Variable cost = $ 40.

>> Net Contribution margin = $ 54 - $ 40

>> Net Contribution margin = $ 14.

>> Total Contribution margin = 5,800 * $ 14

>> Total Contribution margin = $ 81,200.

>> Net Operating income = Contribution margin - Fixed cost

>> Net Operating income = $ 81,200 - $58,800

>> Net Operating income = $ 22,400.

4. Break even sales = Fixed cost / CM ratio

4. Break even sales = $ 58,800 / 20 %

4. Break even sales = $ 294,000.

>> Break even units = $ 294,000 / $ 50

>> Break even units = 5,880 Units