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 $180,000 per year. Its operating results for last year were as follows:

Sales                            $ 2,000,000

Variable expenses            1,000,000

Contribution margin           1,000,000

Fixed expenses                 180,000

Net operating income         $ 820,000

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 $51,000 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 11%. Using the degree of operating leverage from last year, what percentage increase in net operating income will the company realize this year?

5. The sales manager is convinced that a 10% 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 $1.60 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 $820,000 net operating income as last year?

Answer 1

1

What is the product's CM ratio

	Amount $	%
Sales Price	80	100.0%
Less: Variable cost	40	50.0%
Contribution margin	40	50.0%

CM Ratio =40/80 =50%

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2.

break-even point in dollar sales

=Fixed Expanses / CM ratio

=180,000/50%

=$360,000

break-even point in dollar sales =$360,0000

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3. If this year's sales increase by $51,000 and fixed expenses do not change, how much will net operating income increase?

Net operating income increase

=increase in sales x CM ratio

=$51,000 x 50%

=$25,500

Net operating income increase =$25,500

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

degree of operating leverage

=Contribution margin /Net operating income

=1,000,000/820,000

=1.22 times

_________________________________

4-b

percentage increase in net operating income will the company realize this year

=% change in Operating sales x degree of operating leverage

=11% x 1.22

=13.42%

_______________________________

5. The sales manager is convinced that a 10% 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?

Contribution format income statement
	Last year		proposed
	25000 units		31250 units
Sales Price	2000000	80	2250000	72
Less: Variable cost	1000000	40	1250000	40
Contribution margin	1000000	40	1000000	32
Less: Fixed cost	180,000		252,000
Net operating income	820,000		748,000

proposed units =25000x1.25 =31250 units

Selling price =80-10% =80-8=72

_______________________

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

No

Explanation : As there is decrease in Net operating income so sales manager's suggestions should not implemented

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6

Expected total contribution margin =25000 units x1.25 x (80-40-1.60)	1200000
Less; Present total Contribution =25000*40	1000000
Advertise expanses can be increased by	200000

president increase this year's advertising expense =$200,000