Question

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $40 per unit. Variable expenses are $20.00 per unit, and fixed expenses total $160,000 per year. Its operating results for last year were as follows:

PLEASE ONLY ANSWER 5A 5B & 6

Sales	$	1,040,000
Variable expenses		520,000
Contribution margin		520,000
Fixed expenses		160,000
Net operating income	$	360,000

Required:

Answer each question independently based on the original data:

1. What is the product's CM ratio? DO NOT ANSWER

2. Use the CM ratio to determine the break-even point in dollar sales. DO NOT ANSWER

3. If this year's sales increase by $55,000 and fixed expenses do not change, how much will net operating income increase? DO NOT ANSWER

4-a. What is the degree of operating leverage based on last year's sales? DO NOT ANSWER

4-b. Assume the president expects this year's sales to increase by 13%. Using the degree of operating leverage from last year, what percentage increase in net operating income will the company realize this year? DO NOT ANSWER

5. The sales manager is convinced that a 14% reduction in the selling price, combined with a $74,000 increase in advertising, would increase this year's unit sales by 25%.

a. If the sales manager is right, what would be this year's net operating income if his ideas are implemented?

b. Do you recommend implementing the sales manager's suggestions?

6. The president does not want to change the selling price. Instead, he wants to increase the sales commission by $2.40 per unit. He thinks that this move, combined with some increase in advertising, would increase this year's sales by 25%. How much could the president increase this year's advertising expense and still earn the same $360,000 net operating income as last year? Do not prepare an income statement; use the incremental analysis approach.

Answer 1

Solution 5a:

Current selling price per unit = $40

Proposed selling price per unit = $40 * 86% = $34.40 per unit

Current fixed costs = $160,000

Proposed fixed cost after advertising = $160,000 + $74,000 = $234,000

Proposed contribution margin per unit = $34.40 - $20 = $14.40 per unit

Current sales volume = $1,040,000 / $40 = 26000 units

Proposed sales volume = 26000 * 125% = 32500 units

Net operating income if sales manager ideas are implemented = (32500 * $14.40) - $234,000 = $234,000

Solution 5b:

As net operating income is reduced from propsed scenario, therefore sales manager suggestions should not be implemented.

Solution 6:

New variable cost per unit after increase in sales commission = $20 + $2.40 = $22.40

Proposed sales units = 26000*125% = 32500 units

Proposed contribution margin per unit = $40 - $22.40 = $17.60 per unit

Proposed contribution margin = 32500 * $17.60 = $572,000

Current contribution margin = $520,000

Increase in contribution margin in proposed scenario = $572,000 - $520,000 = $52,000

Therefore president can increase advertising expense by $52,000 and still earn same $360,000 net operating income as last year.