Question

Magic Realm, Inc., has developed a new fantasy board game. The company sold 34,000 games last year at a selling price of $63 per game. Fixed expenses associated with the game total $595,000 per year, and variable expenses are $43 per game. Production of the game is entrusted to a printing contractor. Variable expenses consist mostly of payments to this contractor.

Required:

1-a. Prepare a contribution format income statement for the game last year.

1-b. Compute the degree of operating leverage.

2. Management is confident that the company can sell 42,160 games next year (an increase of 8,160 games, or 24%, over last year). Given this assumption:

a. What is the expected percentage increase in net operating income for next year?

b. What is the expected amount of net operating income for next year? (Do not prepare an income statement; use the degree of operating leverage to compute your answer.)

Answer 1

1.a Contribution Format Income Statement for the game last year.

	Total
Sales (34000 units * $63)	$2,142,000
Less: Variable Expense (34000 units * $43)	$1,462,000
Contribution Margin	$680,000
Less: Fixed Expense	$595,000
Net Operating Income	$85,000

1.b Degree of Operating Leverage = Contribution Margin / Net Operating Income

= $680,000 / $85,000

= 8

2.a The Expected Net Operating Income Percentage will be increased by 192% (8 * 24%)*100 in the next year.

2.b The Expected increase in the Net Operating Income Amount will be increased by $248,200 ($85,000 + 192%).