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 $160,000 per year.

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 dollar sales.

       

3.	Due to an increase in demand, the company estimates that sales will increase by $54,000 during the next year. By how much should net operating income increase (or net loss decrease) assuming that fixed expenses do not change?

       

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

Sales	$	1,080,000
Variable expenses		540,000
Contribution margin		540,000
Fixed expenses		160,000
Net operating income	$	380,000

a.	Compute the degree of operating leverage at the current level of sales. (Round your answer to 2 decimal places.)

            

b.	The president expects sales to increase by 19% next year. By what percentage should net operating income increase? (Round intermediate calculations and final answer to 2 decimal places.)

           

5.	Refer to the original data. Assume that the company sold 33,000 units last year. The sales manager is convinced that a 12% reduction in the selling price, combined with a $79,000 increase in advertising, would increase annual unit sales by 50%.

a.	Prepare two contribution format income statements, one showing the results of last year’s operations and one showing the results of operations if these changes are made. (Do not round intermediate calculations. Round your "Per unit" answers to 2 decimal places.)

          

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

6.

Refer to the original data. Assume again that the company sold 33,000 units last year. The president does not want to change the selling price. Instead, he wants to increase the sales commission by $1.50 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? Do not prepare an income statement; use the incremental analysis approach.

     

Answer 1

Answer of Part 1:

Contribution Margin = Selling Price – Variable Expenses
Contribution Margin = $40 - $20
Contribution Margin = $20

Contribution Margin Ratio = Contribution Margin / Selling Price *100
Contribution Margin Ratio = $20 / $40 *100
Contribution Margin Ratio = 50%

Answer of Part 2:

Break Even Point in Dollar Sales = Fixed Expenses / Contribution Margin Ratio
Break Even Point in Dollar Sales = $160,000 / 0.5
Break Even Point in Dollar Sales = $320,000

Answer of Part 3:

Increased Contribution Margin = Increased Sales * Contribution Margin Ratio    
Increased Contribution Margin = $54,000 * 0.5
Increased Contribution Margin = $27,000

Since the fixed expense will not change, net operating income should also increase by $27,000

Answer of Part 4-a:

Degree of Operating Leverage = Contribution Margin / Net Operating income
Degree of Operating Leverage = $540,000 / $380,000
Degree of Operating Leverage = 1.42

Answer of Part 4-b:

Degree of Operating Leverage = % Change in Net Operating Income / % Change in Sales
1.42 = % Change in Net Operating Income / 19
1.42 * 19 = % Change in Net Operating Income
% Change in Net Operating Income = 26.98%