Question

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $80 per unit. Variable expenses are $40.00 per unit, and fixed expenses total $180,000 per year. Its operating results for last year were as follows:

Sales	$	2,000,000
Variable expenses		1,000,000
Contribution margin		1,000,000
Fixed expenses		180,000
Net operating income	$	820,000

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. If this year's sales increase by $47,000 and 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 sales to increase by 13%. 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 12% reduction in the selling price, combined with a $76,000 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. Do you recommend implementing the sales manager's suggestions?

6. The president does not want to change the selling price. Instead, he wants to increase the sales commission by $1.90 per unit. He thinks that this move, combined with some increase in advertising, would increase this year's sales by 25%. How much could the president increase this year's advertising expense and still earn the same $820,000 net operating income as last year? Do not prepare an income statement; use the incremental analysis approach.

Answer 1

1)	CM ratio
	contribution margin/sales
	1,000,000/2,000,000
	0.5
	50%
2)	Break even sales in dollars
	fixed cost/contribution margin ratio
	180,000/50%
	360000
3)	Net operating income will increase by
	47000*50%
	23500
4-a)	Degree of operating leverage
	contribution margin/net income
	1,000,000/820,000
	1.219512
	or 1.22
4b)	percentage increase in net income
	13%*1.22
	15.86
	or 15.86%
5)-a)	unit sale = 2,000,000/80
		25000
	now unit sales =25000*125%
		31250
	selling price new = 80*88%=$70.4
	sales        (31,250*36)	(31250*70.4)			2200000
	Variable expense (31,250*40)				1250000
	Contribution margin				950000
	fixed expense (180,000+76000)				256000
	Net operating income				694000
b)	No
				per unit
6)	sales			80
	Variable expense			41.9
	Contribution margin			38.1
	increase in sales 25%
	(31,250*38.1) - (180,000+x) = 820,000
	1190625 - 180,000-x =820,000
	x                                 =		190,625	asnwer