Question

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $120 per unit. Variable expenses are $60.00 per unit, and fixed expenses total $160,000 per year. Its operating results for last year were as follows: Sales Variable expenses Contribution margin Fixed expenses Net operating income $ 3,240,000 1,620,000 1,620,000 160,000 $ 1,460,000 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 $42,000 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 $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. 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 $1.90 per unit. He

Answer 1

1) Contribution ratio
Selling Price per unit	$           120.00
Less: Variable cost per unit	$             60.00
Contribution Margin per unit	$             60.00
Contribution Margin Ratio = Contribution margin per unit/ selling price per unit
Contribution Margin Ratio = $60/$120	50%
2)
Break-Even Sales (dollars) = (Fixed Expenses / CM Ratio)
Break-Even Sales (dollars) = $160,000 /50%)	$    320,000.00
3)
Change in Contribution Margin = (Change in Sales) x CM ratio
Change in Contribution Margin = $42,000 x 50%	$      21,000.00
Change in Net Operating Income = (Change in Contribution Margin) - (Change in Fixed Expenses)
Change in Net Operating Income = ($21000 - $0)	$      21,000.00
If sales increase by $42,000, net operating income will increase by $21,000
4) a.
DOL =(Contribution Margin / Net Operating Income).
DOL = $1,620,000/$1,460,000	1.110
b.
DOL = % Change in NOI/% Change in sales
% Change in Net Operating Income = DOL x (% Change in Sales)
% Change in Net Operating Income = 1.11 x 14% =	15.53%
Thus a 14% increase in sales should result in a 15.53% increase in net operating income.
5)
	Last Year:		Proposed:
Units	27000		33750
	Total	Per Unit	Total	Per unit
Sales	$ 3,240,000.00	$     120.00	$3,483,000	$103.20
Variable expenses	$ 1,620,000.00	$       60.00	$2,025,000	$             60.00
Contribution margin	$ 1,620,000.00	$       60.00	$1,458,000
Fixed expenses	$    160,000.00		$   234,000.00
(a) Net operating income	$ 1,460,000.00		$1,224,000.00
(b) Net operating income decrease by	($236,000.00)
278,000 units × 1.25 = 33,750 units
$120 per unit × (1-14%) = $103.20 per unit
No, the changes should not be made.
6)
Expected total contribution margin: 27,000 units × 1.25 × $120 - ($60+$1.90) per unit	$1,960,875.00
Present total contribution margin: 27,000 units × $60 per unit	$ 1,620,000.00
Incremental contribution margin, and the amount by which advertising can be increased with net operating income remaining unchanged	$340,875