Question

Jim Sandalwood has recently opened The Sandal Hut in Brisbane, Australia, a store that specializes in fashionable sandals. Jim has just received a degree in business and he is anxious to apply the principles he has learned to his business. In time, he hopes to open a chain of sandal shops. As a first step, he has prepared the following analysis for his new store:

Sales price per pair of sandals	$	50.00
Variable expenses per pair of sandals		30.00
Contribution margin per pair of sandals	$	20.00
Fixed expenses per year:
Building rental	$	18,000
Equipment depreciation		6,000
Selling		32,000
Administrative		34,000
Total fixed expenses	$	90,000

Required:

1.	How many pairs of sandals must be sold to break even? What does this represent in total dollar sales?

    

3.	Jim has decided that he must earn at least $25,000 the first year to justify his time and effort. How many pairs of sandals must be sold to reach this target profit?

4.	Jim now has one salesperson working in the store -- one part time. It will cost him an additional $12,000 per year to convert the part-time position to a full-time position. Jim believes that the change would bring in an additional $80,000 in sales each year. Should he convert the position? Use the incremental approach.
	Yes No

5.	Refer to the original data. During the first year, the store sold only 5,250 pairs of sandals and reported the following operating results:

Sales (5,250 pairs)	$	262,500
Less variable expenses		157,500
Contribution margin		105,000
Less fixed expenses		90,000
Net operating income	$	15,000

a.	What is the store’s degree of operating leverage?

b.	Jim is confident that with a more intense sales effort and with a more creative advertising program he can increase sales by 10% next year. What would be the expected percentage increase in net operating income? Use the degree of operating leverage concept to compute your answer.

Answer 1

1
Total fixed expenses	90000
Divide by Contribution margin per pair of sandal	20
Break even point in unit sales	4500	pairs
Break even point in dollar sales	225000	=4500*50
3
Total fixed expenses	90000
Add: Target profit	25000
Required contribution margin	115000
Divide by Contribution margin per pair of sandal	20
Unit sales to attin target profit	5750	pairs
4
Incremental sales	80000
X Contribution margin ratio	40%	=20/50
Incremental contribution margin	32000
Less: Additonal costs	12000
Incremental income	20000
Yes, convert the position
5a
Contribution margin	105000
Divide by Net operating income	15000
Degree of operating leverage	7
b
Percentage increase in sales	10%
X Degree of operating leverage	7
Percentage increase in net operating income	70%