Question

In: Accounting

E7-34A Terry's Towing Service has a monthly target operating income of $30,000. Variable expenses are 40%...

E7-34A Terry's Towing Service has a monthly target operating income of $30,000. Variable expenses are 40% of sales and monthly fixed expenses are $7,500

1. Compute the monthly margin of safety in dollars if the shop achieves its income goal.

2. Express Terry's margin of safety as a percentage of target sales

3. What is Terry's operating leverage factor at the target level of operating income? 4. Assume that the company reaches its target. By what percentage will the company's operating income fall if sales volume declines by 12%?

Solutions

Expert Solution

  • All working form part of the answer
  • Amounts are in $
  • Working for target Sales Revenue

Target Income

$30000

(+) Fixed expenses

$7500

Contribution margin

$37500

Variable cost

40% of sale

Contribution margin will be

60% of sale

Total target Sales Revenue [37500 / 60%]

$62500

  • Working for Break Even point Sales in dollars

Fixed expenses

$7500

Contribution margin ratio

$60%

Break Even Sale [7500/60%]

$12500

  • Answer 1: Margin of safety

Total Sales Revenue

$62500

(-) Break Even Sales Revenue

$12500

Margin of Safety in Dollars

$50000

  • Answer 2: Margin of Safety as sales percentage

Margin of Safety in Dollars

$50000

Total target Sales Revenue

$62500

Margin of Safety as percentage of target Sale [50000/62500]

80%

  • Answer 3: Operating Leverage

Contribution margin [62500 x 60%]

$37500

Operating Income [Target Income]

$30000

Operating leverage [37500/30000]

1.25

  • Answer 4: % change in Operating Income if Sales volume decreases

Sales Volume Declines by

12%

Company's operating income will fall by [12% x Operating Leverage] = [12% x 1.25]

15%


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