Question

ColorColor

Rugs is holding a? 2-week carpet sale at

Jacob'sJacob's

?Club, a local warehouse store.

ColorColor

Rugs plans to sell carpets for

$ 1 comma 000$1,000

each. The company will purchase the carpets from a local distributor for

$ 400$400

?each, with the privilege of returning any unsold units for a full refund.

Jacob'sJacob's

Club has offered

ColorColor

Rugs two payment alternatives for the use of space.

times•

Option? 1: A fixed payment of

$ 17 comma 400$17,400

for the sale period

times•

Option? 2:

2020?%

of total revenues earned during the sale periodAssume

ColorColor

Rugs will incur no other costs.Read the requirements

.	Calculate the breakeven point in units for? (a) option 1 and? (b) option 2.
2.	At what level of revenues will ColorColor Rugs earn the same operating income under either? option?
	a. For what range of unit sales will ColorColor Rugs prefer option? 1?
	b. For what range of unit sales will ColorColor Rugs prefer option? 2?
3.	Calculate the degree of operating leverage at sales of 8787 units for the two rental options.
4.	Briefly explain and interpret your answer to requirement 3.

.

Requirement 1. Calculate the breakeven point in units for? (a) option 1 and? (b) option 2.

Begin by determining the formula to calculate the breakeven point in units.

Number of units to breakeven

?=

Fixed cost Contribution margin per unit

Calculate the breakeven point in units for option? 1, then option 2. ?(Round your answers up to the nearest whole number. Enter? "0" for zero? balances.)

	Units
(a) Option 1
(b) Option 2

Answer 1

Requirement 1
Calculation of break even point
option 1	=fixed rent/(contribution per unit)
	=$17,400/($1,000-$400)
	29 Units
option 2	=fixed rent/(contribution per unit)
	=0/($1,000-$200-$400)
	0 units

Requirement 2

let assume no. of units sold being "x"

x*$600-$17,400=x*$400

Therefor x = 87 units

Hence at sales of 87 units operating income will be same under both the options

a. color rugs prefer option 1 when sales is more than 87 units as veriable cost is lower.

b. color rugs prefer option 2 when sales is less than 87 units as fixed cost is lower.

Requirement 3
Calculation of degree of operating leverage at sale volume of 87 units
	option 1	option 2
sales	$ 87,000	$ 87,000
variable cost	$ 34,800	$ 52,200
Contribution	$ 52,200	$ 34,800
fixed cost	$ 17,400	$          -
Net operating income	$ 34,800	$ 34,800
Operating leverage	150%	100%

Requirement 4

Operating leverage indicate the dgree to which a firm incures a combination of fixed cost and variable cost. High degree of operating leverage indicate high fixed cost burden and Low degree of operating leverage indicate low fixed cost burden. As we can see option 1 has more fixed cost burden than option 2 that is why opetion 1 has High operating leverage.