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 $55,000 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 16%. 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 15% reduction in the selling price, combined with a $80,000 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. If the sales manager's ideas are implemented, how much will net operating income increase or decrease over last year?

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 $820,000 net operating income as last year?

Answer 1

1) compute the contribution margin ratio

CONTRIBUTION MARGIN ratio = CONTRIBUTION MARGIN/sales×100

= $1000000/$2000000×100

= 50%

2) COMPUTE BREAK EVEN SALES IN DOLLARS

BREAK EVEN SALES IN DOLLARS = FIXED COST/CONTRIBUTION MARGIN ratio

=$180000/50%

. = $360000

3)if sales increase by $55000 no change in fixed cost then operating income Will be

Particular	amount ($)
Sales (increase by$55000)	$2055000
(-) variable expenses	($1027500)
CONTRIBUTION	$1027500
(-) fixed expenses	($180000)
New net operating income	$847500

Old net operating income - New net operating income = increase/DECREASE

$820000 -. $847500 = $27500

Increase by$27500

4a) compute degree of operating leverage

degree of operating leverage =CONTRIBUTION/NET OPERATING INCOME

= $1000000/$820000

=1.22

4b) % increase in operating income =%increase in sales×degree of OPERATING LEVERAGE

= 1.22×16% = 0.20 %

new operating leverage =1.42

5)if selling price reduce by 15%then new selling price

=$80-15%=$68

Increase in advertising expenses by$80000

therefore new fixed cost = $180000+$80000= $260000

sales units increase by 25%

$2000000/$80+25%

25000units +25= 31250units

Particular	amount ($)
Sales (31250×$68)	2125000
(-) variable expenses	(1062500)
CONTRIBUTION MARGIN	1062500
(-) fixed expenses	(260000)
Net operating income	802500

5b) decrease in net operating income= $820000 - $802500

=$17500

6)if sales commission increases by $2.40per unit

then New CONTRIBUTION MARGIN PER UNIT= $80-$40 - $2.40 = $37.6

NEW sales volume= 25000+25%=31250units

Target operating income=$820000

Maximum fixed cost= CONTRIBUTION MARGIN - Target operating income

= (31250×$37.60)-$820000

= $1175000 - $820000= $355000

existing fixed cost=$180000

Therefore advertising amount can be increased by= $355000- $180000=$175000

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