Question

. Thad Morgan, a motorcycle enthusiast, has been exploring the possibility of relaunching the Western Hombre brand of cycle that was popular in the 1930s. The retro-look cycle would be sold for $12,000 and at that price, Thad estimates 300 units would be sold each year. The variable cost to produce and sell the cycles would be $8,400 per unit. The annual fixed cost would be $810,000. a. What is the break-even in unit sales?b. What is the margin of safety in dollars?c. What is the degree of operating leverage? (Round your answer to 2 decimal places.)

Thad is worried about the selling price. Rumors are circulating that other retro brands of cycles may be revived. If so, the selling price for the Western Hombre would have to be reduced to $9,800 to compete effectively. In that event, Thad would also reduce fixed expenses to $640,000 by reducing advertising expenses, but he still hopes to sell 300 units per year.

d. What would the net operating income be in this situation?

Answer 1

Selling price per unit = 12,000

Sales in units = 300

Variable costs = 8,400 per unit

Fixed cost = 810,000

a.

Contribution margin per unit = Selling price per unit - Variable costs per unit

= 12,000 - 8,400

= 3,600

Breakeven in unit sales = Fixed costs / Contribution margin per unit

= 810,000 / 3,600

= 225

b.

Revenues = 300 units * 12,000 per unit = 3,600,000

Breakeven revenues = Breakeven units * Selling price per unit

= 225 * 12,000

= 2,700,000

Margin of safety in dollars = Revenues - Breakeven revenues

= 3,600,000 - 2,700,000

= 900,000

c.

Sales (12,000*300)	3,600,000
Variable costs (8,400*300)	2,520,000
Contribution margin	1,080,000
Fixed costs	810,000
Operating income	270,000

Degree of operating leverage = Contribution margin / Operating income

= 1,080,000 / 270,000

= 4 times

d.

Selling price per unit = 9,800

Variable cost per unit = 8,400

Fixed costs = 640,000

Units sold = 300

Sales (300 * 9,800)	2,940,000
Variable costs (300*8,400)	2,520,000
Contribution margin	420,000
Fixed costs	640,000
Operating income (loss)	(220,000)