Question

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $40 per unit. Variable expenses are $20.00 per unit, and fixed expenses total $180,000 per year. Its operating results for last year were as follows:

Sales	$	960,000
Variable expenses		480,000
Contribution margin		480,000
Fixed expenses		180,000
Net operating income	$	300,000

Required:

Answer each question independently based on the original data:

1. What is the product's CM ratio?

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

3. Assume this year’s unit sales and total sales increase by 58,000 units and $2,320,000, respectively. If the fixed expenses do not change, how much will net operating income increase?

4-a. What is the degree of operating leverage based on last year's sales?

4-b. Assume the president expects this year's unit sales to increase by 11%. Using the degree of operating leverage from last year, what percentage increase in net operating income will the company realize this year?

5. The sales manager is convinced that a 14% reduction in the selling price, combined with a $69,000 increase in advertising, would increase this year's unit sales by 25%.

a. If the sales manager is right, what would be this year's net operating income if his ideas are implemented?

b. If the sales manager's ideas are implemented, how much will net operating income increase or decrease over last year?

6. The president does not want to change the selling price. Instead, he wants to increase the sales commission by $2.30 per unit. He thinks that this move, combined with some increase in advertising, would increase this year's unit sales by 25%. How much could the president increase this year's advertising expense and still earn the same $300,000 net operating income as last year?

Answer 1

Solution 1:
Sales Price	40
Less: Variable cost per unit	20
Contribution Margin per unit	20
Contribution Margin ratio	50.00%
Solution 2:
Fixed costs	180000
/Contribution Margin ratio	50%
Break-even point in sales dollars	360000
Solution 3:
Increase in sales	2320000
*Contribution Margin ratio	50%
Net operating income Increase by	1160000
Solution 4-a:
Total Contribution margin	480000
/ Net operating income	300000
Degree of operating leverage	1.60
Solution 4-b:
% Increase in sales	11%
*Degree of operating leverage	1.60
Net operating income Increase by	17.60%
Solution 5-a:
Feather friend Inc.
Contribution Income statement
	Last Year	Proposed
	24000	units	30000	units
Particulars	Total	Per unit	Total	Per unit
Sales	960000	40	1032000	34.40
Variable expenses	480000	20	600000	20
Contribution margin	480000	20	432000	14.4
Fixed expenses	180000		249000
Net operating income	300000		183000
Solution 5-b:
Increase (Decrease) in net operating income	-117000
Solution 6:
Existing contribution margin per unit	20
Less: Increase in sales commission	2.30
New contribution margin per unit	17.70
New sales units	30000
*New contribution margin per unit	17.70
Total Contribution margin	531000
Less: Target operating income	300000
Minimum Fixed cost	231000
Less: existing fixed cost	180000
Amount by which advertising can be increased =	51000