Question

Exercise 19-15 a-c Casas Modernas of Juarez, Mexico, is contemplating a major change in its cost structure. Currently, all of its drafting work is performed by skilled draftsmen. Rafael Jiminez, Casas' owner, is considering replacing the draftsmen with a computerized drafting system. However, before making the change, Rafael would like to know the consequences of the change, since the volume of business varies significantly from year to year. Shown below are CVP income statements for each alternative. Manual System Computerized System Sales Variable costs Contribution margin Fixed costs $1,740,000 1,392,000 348,000 108,000 $240,000 $1,740,000 696,000 1,044,000 804,000 $240,000 Net income Determine the degree of operating leverage for each alternative. (Round answers to 2 decimal places, e.g. 1.25.) Degree of Operating Leverage Manual System Computerized System Calculate the increase in Net income for each alternative if sales increased by $123,000. Increase in Net Income Manual System Computerized System

Answer 1

a)
Degree of operating Leverage = Contribution Margin / Operating Income
Manual System:
Degree of operating leverage = 348000 / 240000
	= 1.45
Computerized System
Degree of operating leverage = 1044000/ 240000
	= 4.35
b)
If sales will increase by $ 123000
	Manual system	computerized system
Sales	1,863,000	1863000
Variable cost	1,490,400	745,200
	[(1392000/1740000)×1,863,000]	[(696000/1740000)×1863000]
Contribution margin	372,600	1,117,800
Fixed Cost	108000	804000
net income	264,600	313,800
Increase in net Income	24600	73,800
	(264,600-240000)	(313,800-240000)
c)
Break even point ( in sales)	Manual system	computerized
based on (a) above		system
Fixed Cost	108000	804000
Contribution %	348000/1740000=20%	1044000/1740000=60%
Variable cost	80%	40%
Break even Sales required	540000	1,340,000
	( 108000 / 20%)	(804000/60%)
Margin of safety ratio	0.6896	0.2299
Manual System
Margin of safety Ratio = (Actual Sales - Break even sales) / Actual Sales
= ( 1740000 - 540000) / 1740000
	=0.6896
Computerised system
Margin of safety Ratio = (Actual Sales - Break even sales) / Actual Sales
= ( 1740000 -1,340,000 ) / 1740000
= 0.2299