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 Variable expenses Contribution margin Fixed expenses Net operating income $ 2,160,000 1,080,000 1,080,000 180,000 $ 900,000 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 $45,000 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 11%. 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 13% reduction in the selling price, combined with a $64,000 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 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 $900,000 net operating income as last year?

Answer 1

Req 1 :
CM ratio = Contribution margin / Sales = 1080000 / 2160000	50%
Req 2 :
Break-even point in dollar sales = Fixed expenses / CM ratio = 180000 / 50%	360000

Req 3 :
Increase in net operating income = ( Increase in sales * CM ratio ) - Increase in fixed expense = ( 45000 * 50% ) - 0	22500

Net operating income

increases

by

22500

Req 4A :
Degree of operating leverage = Contribution margin / Net operating margin = 1080000 / 900000	1.20

Req 4B :
Degree of operating leverage = % change in net operating income / % change in sales
1.20 = % change in net operating income / 11%
% change in net operating income = 1.20 * 11%	13.20%

Net operating income increase by

13.20%

Req 5 :
Last year's unit sales = Sales / Selling price = 2160000 / 80	27000
After changes :
Selling price = Current selling price * ( 1 - % reduction ) = 80 * ( 1 -13% )	69.60
Fixed expenses = Current fixed expenses + Increase in adverstising expense = 180000 + 64000	244000
Unit sales = Last year's unit sales * ( 1 + % increase ) = 27000 * ( 1 + 25% )	33750

a.
Sales ( 33750 * 69.60 )	2349000
(-) Variable expenses ( 33750 * 40 )	1350000
Contribution margin	999000
(-) Fixed expenses	244000
Net operating income	755000
b.
Last year's net operating income	900000
(-) This year's budgeted net operating income	755000
Decrease in net operating income	145000

6.
After change :
Unit sales = Last year's unit sales * ( 1 + % increase ) = 27000 * ( 1 + 25% )	33750
Variable expense per unit = Current variable expense per unit + Increase in sales commission per unit = 40 + 1.90	41.90
Net operating income = Unit sales * ( Selling price - Variable cost per unit ) - Fixed expenses
900000 = 33750 * ( 80 - 41.90 ) - Fixed expense
900000 = 1285875 - Fixed expense
Fixed expense = 1285875 - 900000	385875

The amount by which advertising can be increase is = Fixed expenses after changes - Current fixed expenses = 385375 - 180000

205375