Question

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $80 per unit. Variable expenses are $40.00 per unit, and fixed expenses total $160,000 per year. Its operating results for last year were as follows: 

Sales	$	2,240,000
Variable expenses		1,120,000
Contribution margin		1,120,000
Fixed expenses		160,000
Net operating income	$	960,000

Required: Answer each question independently based on the original data: 

1. What is the product's CM ratio? 

2. Use the CM ratio to determine the break-even point in dollar sales. 

3. If this year's sales increase by $40,000 and fixed expenses do not change, how much will net operating income increase? 

4-a. What is the degree of operating leverage based on last year's sales? 

4-b. Assume the president expects this year's sales to increase by 12%. Using the degree of operating leverage from last year, what percentage increase in net operating income will the company realize this year? 

Answer 1

1)Contribution Margin Ratio (CM ratio) =Contribution Margin / Sales

Sales = $80 per unit

Variable Cost = $40 per unit

Contribution Margin = Sales - Variable Cost

Contribution Margin = $80 - $40 =$40

CM ratio = $40/ $80

CM ratio = 0.50 or 50%

2) Break - even point dollars sales = Fixed expenses / CM ratio

Fixed Expenses =$160,000

Break - even point dollars sales = $160,000/ 50%

Break - even point dollars sales = $320,000

3)If Sales Increase by $40,000 then Net Operating income increases as follows :-

Increases in Net Operating Income = Increase in Sales × CM ratio

Increases in Net Operating Income = $40,000 × 50%

Increases in Net Operating Income = $20,000

If sales increase by $40,000 then Net Operating income increase by $20,000 as there is no change in Fixed expenses.

​​​​​​4)a)Degree of operating leverage = Contribution margin/Net operating income

Contribution Margin = $1,120,000

Net Operating Income = $960,000

Degrees of Operating leverage = $1,120,000/ $960,000

Degrees of Operating Leverage = 1.17