Question

Hurst Co. manufacturers and sells a single product. Price and cost data regarding this product are as follows: selling price $40 per unit variable manuf. cost $20 per unit variable selling& admin $6 per unit fixed MOH 208,000 per yr fixed selling and admin $325,000 per yr d. Using the current sales level of 43,500, what is the operating leverage? Use the operating leverage to predict the increase in net income if sales increase by 20%. Prove the percentage increase predicted by preparing a contribution margin format income statement.

Answer 1

Calculation of Profit/Loss:

Sales                (43,500* $ 40)             = $ 1,740,000

-Variable cost(20+6)=(43,500* $ 26) = $ 1,131,000

=Contribution margin                         = $ 609,000

-Fixed cost(208,000+325,000)           = $ 533,000

= Net operating Profit                         = $ 76,000

Degree of operating leverage = Contribution margin/ Net operating profit

=609,000/76,000 = 8.013

Expected percentage increase in net operating income if sales increased by 20%:

(Percentage change in sales × 8.013) = 20%*8 = 160.26%

Expected increase in total net operating income if sales increased by 20%:

            = 76,000*160.26%= $ 121,800

Expected total net operating income if sales increased by 20%:

= $ 76,000 + $ 121,800

= $ 197,800

Proof:

If 20% increase in sales:

Sales (43,500*120/100) (52,200*$40)= $ 2,088,000

-Variable cost(20+6)=(52,200* $ 26) = $ 1,357,200

=Contribution margin                         = $ 730,800

-Fixed cost(208,000+325,000)           = $ 533,000

= Net operating Profit                         = $ 197,800