Question

Granite industries’ margin of safety as a percentage of its sales is 20%. Granite’s break-even sales are $500000 and its variable costs are 60% of sales. what is Granite’s operating income

Answer 1

Granite’s operating income is $ 50,000

Step-1:Calculation of fixed costs
There are two types of cost (a) Variable cost and (b) Fixed Cost
Variable cost per unit remains same and changes in total with the change in volume of sales.
Fixed Cost in total does not change with change in volume of sales.
Further, total sales is equal to total costs at break even level.
So, at break even sales,
Sales		a		$       5,00,000
Variable cost		b=a*60%		$       3,00,000
Fixed Cost		c=a-b		$       2,00,000
Step-2:Calculation of total sales of Granite industries
Margin of safety is the sales level in excess of break even sales.
In other words, total sales is sum of break even sales and margin of safety sales.
So,
Total Sales		=	Break even sales	/	(1- Margin of safety ratio)
		=	$       5,00,000	/	(1-0.20)
		=	$       6,25,000
Step-3:Calculation of operating income
Sales		a	$       6,25,000
Variable cost		b=a*60%	$       3,75,000
Contribution Margin		c=a-b	$       2,50,000
Fixed Costs		d	$       2,00,000
Net Operating Income		e=c-d	$           50,000