Question

please answer all questions

Questions: 1. What is the meaning of contribution margin ration? How is this ratio useful in planning business operations? 2. In all respects, Company A and Company B are identical except that Company A's costs are mostly variable whereas Company B's costs are mostly fixed. When sales increase, which company will tend to realize the greatest increase in profits? Explain. 3. What is the meaning of operating leverage? 4. What is the meaning of break-even point? Problem: Oslo Company prepared the following contribution format income statement based on a sales volume of 1,000 units (the relevant range of production is 500 units to 1,500 units): I Sales $ 20,00 0 Variable expenses 12.00 0 Contribution margin 8,000 Fixed expenses 6.000 Net operating income $ 2,000 Required: 1. What is the contribution margin per unit? 2. What is the contribution margin ratio? 3. What is the variable expense ratio? 4. If sales increase to 1,001 units, what would be the increase in net operating income? 5. If sales decline to 900 units, what would be the net operating income? 6. If the selling price increases by $2 per unit and the sales volume decreases by 100 units, what would be the net operating income? 7. If the variable cost per unit increases by $1, spending on advertising increases by $1,500, and unit sales increase by 250 units, what would be the net operating income? 8. What is the break-even point in unit sales? 9. What is the break-even point in dollar sales?

Answer 1

1. Contribution margin ratio is the ratio of contribution margin to sales. Contribution margin is difference between sales and variable cost. Contribution margin ratio is helpful in following ways

· It helps in estimation of total cost

· It helps in evaluation of various alternative for example : advertising spend

· It helps in break even analysis

· It helps in calculation of margin of safety

· It helps in calculation of profitablity at different level of sales

2. The Company having higher operating leverage tend to realises the greatest increase in profit. Company B profits will increase higher compared to Company A because it has lower variable cost and its contribution margin will be higher when sales increases. Fixed cost does not change and hence it has higher operating leverage.

3. Operating leverage is the measure of how operating income of a company will change in response to a change in sales. It is calculated dividing contribution margin by Operating income. Companies with higher proportion of fixed cost to variable cost will have higher operating leverage

4. Breakeven point is the point at which there is no profit or no loss. At Breakeven point contribution margin is equal to fixed cost and company will have zero operating income.

1 Total contribution margin Total units Contribution margin $8,000 1,000 $8.00 2 Contribution margin ratio Total contribution margin Sales Contribution margin ratio $8,000 $20,000 40% 3 Variable cost ratio 60%(1- Contribution margin ratio) 4 If sales increases to 1001 Increase in operating income (1 units * Contribution margin) 5 Net Operating Income $1,200 Sales units Sales Variable cost Contribution margin Fixed cost Net operating income 900 Total $18,000 $10,800 $7,200 $6,000 $1,200 per unit $20.00 $12.00 $8.00 Working notes: Existing Sales Variable cost Total $20,000 $12,000 per unit $20.00 $12.00 6 Net operating income $3,000 Sales units per unit Sales Variable cost Contribution margin Fixed cost Net operating income 900 Total $19,800 $10,800 $9,000 $6,000 $3,000 $22.000 $12.00 $10.00 7 Net operating income $1,250 Sales units Sales Variable cost Contribution margin Fixed cost Net operating income 1,250/250 units increase Total per unit $25,000 $20.00 same $16,250 $13.00 Increase by $1 $8,750 $7.00 $7,500 $6,000+ $1,500 $1,250 8 Units Break-even point in sales units Fixed Cost Contribution margin per unit $6,000 $8.00 750 Sales $ 9 Break-even point in sales $ Fixed Cost Contribution Margin ratio $6,000 40.00% $15,000 10 Units Units to sell to achieve target profit Fixed Cost + Target profit Contribution margin per unit $11,000 $8.00 1,375 $5,000 11 Margin of safety in dollars (Total sales - Beak even sales) Margin of safety percentage (Margin of Safety/Actual sales)*100 25.0% ($5,000/$20,000)*100 Actual sales Break even sales Margin of safety in dollars $20,000 $15,000 B $5,000 A-B 12 Operating leverage Contribution margin Net operating income $8,000 $2,000 4.0 13 Increase in net operating income 20.00% (5%+4) (Increase in sales * Operating leverage 14 Operating leverage Contribution margin Net operating income $14,000 $2,000 7.0 Sales Variable cost Contribution margin Fixed cost Net Income $20,000 $6,000 $14,000 $12,000 $2,000 15 Increase in net operating income 35.00% (5%*7) (Increase in sales * Operating leverage)