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 $200,000 per year. Its operating results for last year were as follows: Sales $ 1,120,000 Variable expenses 560,000 Contribution margin 560,000 Fixed expenses 200,000 Net operating income $ 360,000 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 $58,000 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 14%. 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 14% 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. 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 $2.10 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

Req 1.
Selling price per unit			40
Less: Variable cost per unit			20
Contribution margin per unit			20
CM ratio: Contirbution/ Selling price *100
	20/40*100 = 50%
Req 2.
Fixed cost			200000
Divide: CM ratio			50%
Break even in $			400000
Req 3.
Increase in Sales			58000
CM ratio			50%
Increase in Operating income			29000
(58000*50%)
Req 4-a:
Degree of operating leverage = Contribution/ Net income
			560000/360000 = 1.56
Req 4-b:
Increase in sales revenue			14%
Degree of Operating leverage			1.56
Increase in Income			21.84%
Req 5.
Sales units (1120000/40)			28000
Revised Sales units (28000+25%)			35000
Revised Selling price (40-14%)			34.4
Sales revenue (35000*34.4)			1204000
Less: Variable cost (35000*20)			700000
Contribution			504000
Less: Fixed cost			200000
Less: Advertisement cost			80000
Net Income			224000
Req 5-b:
No, manager suggestion shall not be implemented.
Req 6.
Revised Sales units:			35000
Revised Variable cost (20+2.10)			22.1
Revised contribution (35000*17.9)			626500
Less: Original contribution			560000
Incremental Contribution			66500
Therefore, additional advertisement expense that can be incurred is $ 66500