Question

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $120 per unit. Variable expenses are $60.00 per unit, and fixed expenses total $180,000 per year. Required: Answer the following independent questions: 1. What is the product's CM ratio? 2. Use the CM ratio to determine the break-even point in dollar sales. 3. Due to an increase in demand, the company estimates that sales will increase by $44,000 during the next year. By how much should net operating income increase (or net loss decrease) assuming that fixed expenses do not change? 4. Assume that the operating results for last year were: Sales $ 3,120,000 Variable expenses 1,560,000 Contribution margin 1,560,000 Fixed expenses 180,000 Net operating income $ 1,380,000 a. Compute the degree of operating leverage at the current level of sales. (Round your answer to 2 decimal places.) b. The president expects sales to increase by 19% next year. By what percentage should net operating income increase? (Round intermediate calculations and final answer to 2 decimal places.) 5. Refer to the original data. Assume that the company sold 43,500 units last year. The sales manager is convinced that a 10% reduction in the selling price, combined with a $72,000 increase in advertising, would increase annual unit sales by 50%. a. Prepare two contribution format income statements, one showing the results of last year’s operations and one showing the results of operations if these changes are made. (Do not round intermediate calculations. Round your "Per unit" answers to 2 decimal places.) b. Would you recommend that the company do as the sales manager suggests? Yes No 6. Refer to the original data. Assume again that the company sold 43,500 units last year. The president does not want to change the selling price. Instead, he wants to increase the sales

Answer 1

1.

Selling Price	120
Variable Cost	(60)
Contribution Margin	60
Contribution Margin (%)	50%

2.

Breakeven Sales ($)= Fixed Cost / Contribution Margin (%) = = 180,000 / 50% = 360,000

3.

Since fixed cost remains unchanged, increase in income will be calculated as follows:

Increase in net operating income = Increase in Sales * CM(%) = 44,000 * 50% = 22,000

4(a).

Operating Leverage = Contribution Margin / Net Operating Income = 1,560,000 / 1,380,000 = 1.13 (rounded off )

4(b)

	Last Year	Next Year (Increase 19%)
Sales	31,20,000	37,12,800
Variable Cost	(15,60,000)	(18,56,400)
Contriution Margin	15,60,000	18,56,400
Fixed Cost	(1,80,000)	(1,80,000)
Net Operating Income	13,80,000	16,76,400

Increase in Net Operating Income = (1676400 / 1380000) / 1380000 = 21.48%

Other way of calculating Increase in Income = Operating Leverage * Increase in Sales = 1.13 * 19 = 21.48%

5.

	Last Year	Current Year
Units Sales	43,500	65,250
Selling Price	120	108
Variable Cost	(60)	(60)
Contribution Margin	60	48
Total Contribution Margin	26,10,000	31,32,000
Fixed Cost	(1,80,000)	(1,80,000)
Advertisement Cost	-	(72,000)
Net Operating Income	24,30,000	28,80,000

Since there is increase in net operating Income by $ 450,000, it is suggested that sales manager proposal be accepted.