Question

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $20 per unit Variable expenses are 58 per un 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 $ 400,000 160,000 240,000 180,000 $ 60,00 ak 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 $75,000 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 20%. 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 10% reduction in the selling price, combined with a $30,000 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?

Answer 1

1.

Sales	$        400,000
Variable Expense	$        160,000
Contribution	$        240,000
Contribution Margin	60%

2.

Sales	$        400,000
Variable Expense	$        160,000
Contribution	$        240,000
Contribution Margin	60%
Fixed Cost	$        180,000
Breakeven (Fixed Cost / Contribution Margin	$        300,000

3.

	Earlier	New	Increase
Sales	$ 400,000	$ 475,000	$ 75,000
Variable Expense	$ 160,000	$ 190,000
Contribution	$ 240,000	$ 285,000
Contribution Margin	60%	60%
Fixed Cost	$ 180,000	$ 180,000
Profit	$    60,000	$ 105,000	$ 45,000

4.a. Operating leverage = Contribution / Net profit = 2,40,000 / 60,000 = 4x

4.b. Change in operating income = 4*20% = 80%

5.

	Earlier	New
Sales	$ 400,000	$ 450,000
Variable Expense	$ 160,000	$ 180,000
Contribution	$ 240,000	$ 270,000
Contribution Margin	60%	60%
Fixed Cost	$ 180,000	$ 210,000
Profit	$    60,000	$    60,000

Answer 2

Req 1	Product CM Ratio	60.00%
	Note 1:
	CM Ratio = Contribution margin / sales
	Contribution margin	240,000
	Divided by sales	400,000
	CM Ratio	60.00%
Req 2	Break Even points in sales dollar	300,000
	Note 2:
	Break Even points in sales dollar = Fixed expense/CM Ratio
	Fixed expenses	180,000
	Divided by CM Ratio	60.00%
	Break Even points in sales dollar	300,000
Req 3	Net Operating Income Increase by	900,000
	Note 3:
	Effect on income = change in sales * CM Ratio
	Increase in sales	1,500,000
	Multiply by CM Ratio	60%
	Net Operating Income Increase by	900,000
Req 4-a	Degree of Operating Leverage	4.00
	Note 4:
	Operating Leverage = Contribution margin/ Net Income
	Contribution Margin	240,000
	Divided by Net Income	60,000
	Degree of Operating Leverage	4.00
Req 4-b	Net Operating Income(NOI) increase by	80.00%
	Note 5:
	Change in NOI = %age change in sales * operating leverage
	%age change in sales	20%
	Multiply by operating leverage	4.00
	Net Operating Income(NOI) increase by	80.00%
Req 5-a	Contribution Income   statement
		Last Year		Proposed
		20,000	Units	25,000	Units
		Total	Per Unit	Total	Per Unit
	Sales	400,000	20.00	450,000	18.00
	Less: Variable expense	160,000	8.00	200,000	8.00
	Contribution margin	240,000	12.00	250,000	10.00
	Fixed expenses	180,000		210,000
	Net Income	60,000		40,000
Req 5-b	Net Operating Income Decrease by	(20,000)