Question

Stratford Company distributes a lightweight lawn chair that sells for $40 per unit. Variable expenses are $10 per unit, and fixed expenses total $768,000 annually.

Required:

Answer the following independent questions:

1.	What is the product’s CM ratio?

    

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

      

3.	The company estimates that sales will increase by $65,000 during the coming year due to increased demand. By how much should net operating income increase?

    

4.	Assume that the operating results for last year were as follows:

Sales		$	1,280,000
Less: Variable expenses			320,000
Contribution margin			960,000
Less: Fixed expenses			768,000
Net operating income		$	192,000

a.	Compute the degree of operating leverage at the current level of sales. (Round your answer to 1 decimal place.)

           

b.	The president expects sales to increase by 40% next year. By how much should net operating income increase?

             

5-a.

Refer to the original data. Assume that the company sold 34,000 units last year. The sales manager is convinced that a 15% reduction in the selling price, combined with a $136,000 increase in advertising expenditures, would increase annual unit sales by 40%. Prepare two contribution format income statements: one showing the results of last year’s operations, and one showing what the results of operations would be if these changes were made. (Do not round intermediate calculations. Round "Per Unit" answers to 2 decimal places.)

      

5-b.	Would you recommend that the company do as the sales manager suggests?
	Yes No

6.

Refer to the original data. Assume again that the company sold 34,000 units last year. The president feels that it would be unwise to change the selling price. Instead, he wants to increase the sales commission by $2 per unit. He thinks that this move, combined with some increase in advertising, would double annual unit sales. By how much could advertising be increased with profits remaining unchanged?

    

Answer 1

1. Product's CM ratio = (Selling price - Variable costs ) / Selling Price

Product's CM ratio = ($40 - $10 / $40

Product's CM ratio = 75%

2. Break Even Point in Sales dollars = Fixed Cost / Contribution Margin Ratio

Break Even Point in Sales dollars = $768000 / 75%

Break Even Point in Sales dollars = $1024000

3. Expected Net Operating Income increase = Expected Sales Increase * Contribution Margin Ratio

Expected Net Operating Income increase = $65000 * 75% = $48750

4. Degree of Operating Leverage = Contribution Margin / Net Operating Income

Degree of Operating Leverage = $960000 / $192000

Degree of Operating Leverage = 5

5.

Increase in % of Net Income = Degree of Operating leverage * Expected Increase in Sales

Increase in % of Net Income = 5 * 40% = 200%

increase in Net Income.In dollars = 200% * $192000 (current NOI) = $384000 additional income

Increase in % of net income = 200%

Increase in $ of net income = $384000

5. Net Results showing changes made

Proposed # of units: 34000 *1.4 = 47600 units

Sales per unit: $40 per unit (previous year's amount) - ($40 * .15%%) = $34.00 per unit

5b The Proposed changes are not recommended as it will result in reduction in net income

6. Amount of Advertising Expenses can be increased

Gross sales: 34,500 x $40 = $1360000
Net Income: 1360000 - 34500 * 10 - 768000 = $252

Net Income at 2x the sales: Current Net Income + increase in sales * Past year's Contribution Margin - Sales Commission

Net income at 2x the sales: $252000 + 34500 * $30 - 69000 * $2

Net income at 2x the sales: $1149000

Excess available for advertizing: net Income at 2x sales - current net income

Excess available for advertizing: $1149000 - $252000 = $897000