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Question: 1.       Feather Friends, Inc., distributes a high- quality wooden ...

1.       Feather Friends, Inc., distributes a high- quality wooden birdhouse that sells for $ 20 per unit. Variable expenses are $ 8 per unit, and fixed expenses total $ 180,000 per year.

DO ONLY QUESTION 3-6!!!!!!!!!!!!

3. Due to an increase in demand, the company estimates that sales will increase by $ 75,000 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 400,000

Variable expenses . . . . . . . . . . . . . . . . . . . . . . 160,000

Contribution margin . . . . . . . . . . . . . . . . . . . . .240,000

Fixed expenses . . . . . . . . . . . . . . . . . . . . . . . .   180,000

Net operating income . . . . . . . . . . . . . . . . . . .. $ 60,000

a.       Compute the degree of operating leverage at the current level of sales.

b.       The president expects sales to increase by 20% next year. By what percentage should net operating income increase?

5. Refer to the original data. Assume that the company sold 18,000 units last year. The sales manager is convinced that a 10% reduction in the selling price, combined with a $30,000 increase in advertising, would increase annual unit sales by one- third. Prepare two contri-bution format income statements, one showing the results of last year’s operations and one showing the results of operations if these changes are made. Would you recommend that the company do as the sales manager suggests?

6. Refer to the original data. Assume again that the company sold 18,000 units last year. The president does not want to change the selling price. Instead, he wants to increase the sales commission by $ 1 per unit. He thinks that this move, combined with some increase in advertising, would increase annual sales by 25%. By how much could advertising be increased with profits remaining unchanged? Do not prepare an income statement; use the incremental analysis approach.

Answer 1

Requirement3:
Selling price per unit: $20 per unit
Variable cost per unit: $8 per unit
Contribution per unit: Selling price - Vvariable cost per unit
Contribution per unit: $ 20- $ 8= $ 12 per unit
Contribution margin ratio = Contribution per unit / Selling price *100
		( $12 /$ 20) *100 = 60%
Now, Increase in sales: $ 75,000
Therefore, increase in contribution = Increase in sales * contribution margin ratio
			( $75,000 *60%) = $45,000
No change in Fixed cost.
Therefore, the increase in Net operating income (decrease in loss): $45,000
Requirement4a:
Degree of operating leverage = Contribution / Net operating income
			($240,000 /$60,000) = 4 times
Requirement 4b:
When sales have been increase by 20%, then the percenatge increase in net operating income will be 80% (i.e. 20%*4)
Requirement5:
STATEMENT OF CONTRIBUTION MARGIN STATEMENT ORIGINAL
					AMOUNT $
Sales revenue (18,000 units@$20)					360,000
Less: Vvariable cost (18,000 units @$8)					144,000
Contribution margin					216,000
Less: Fixed cost					180,000
Net operating income					36,000
STATEMENT OF REVISED CONTRIBUTION MARGIN STATEMENT
					AMOUNT $
Sales revenue (24,000 units@$18)					432000
Less: Variable cost (24,000 units@8)					192000
Contribution margin					240000
Less: Fixed cost					180,000
Less: Advertisement cost					30,000
Net operating income					30,000
As the net operating inccome has been reduced, therefore the sales manager proposition is not recommended
Requirement6:
STATEMENT SHOWING INCREMENTAL INCOME ANALYSIS
					AMOUNT $
Incremental sales revenue (18,000*25% @$20)					90000
Less: Incremental variable cost (18,000*25%@$8)					36000
Less: Sales commission (22,500 units@1)					22500
Advertisement cost to be incurred					31500
Therefore, the incremental adverytisement cost that can be incurred is $31,500
The profits in this case shall remain same.