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 $200,000 per year.

Required:
Answer the following independent questions:
1.	What is the product's CM ratio?

       

2.	Use the CM ratio to determine the break-even point in dollar sales.

       

3.	Due to an increase in demand, the company estimates that sales will increase by $45,000 during the next year. By how much should net operating income increase (or net loss decrease) assuming that fixed expenses do not change?

       

4.	Assume that the operating results for last year were:

Sales	$	2,080,000
Variable expenses		1,040,000
Contribution margin		1,040,000
Fixed expenses		200,000
Net operating income	$	840,000

a.	Compute the degree of operating leverage at the current level of sales. (Round your answer to 2 decimal places.)

            

b.	The president expects sales to increase by 20% next year. By what percentage should net operating income increase? (Round intermediate calculations to 2 decimal places and final percentage answer to 2 decimal places, i.e. 22.47%)

           

5.	Refer to the original data. Assume that the company sold 31,500 units last year. The sales manager is convinced that a 10% reduction in the selling price, combined with a $67,000 increase in advertising, would increase annual unit sales by 50%.

a.	Prepare two contribution format income statements, one showing the results of last year’s operations and one showing the results of operations if these changes are made. (Do not round intermediate calculations. Round your "Per unit" answers to 2 decimal places.)

          

b.

Would you recommend that the company do as the sales manager suggests?

	Yes
	No

6.

Refer to the original data. Assume again that the company sold 31,500 units last year. The president does not want to change the selling price. Instead, he wants to increase the sales commission by $1.60 per unit. He thinks that this move, combined with some increase in advertising, would double annual unit sales. By how much could advertising be increased with profits remaining unchanged? Do not prepare an income statement; use the incremental analysis approach.

     

Answer 1

	Sales	$80.00
	Less: Variable	$40.00
	Contribution	$40.00
	Fixed expenses	$200,000
1	Contribution margin ratio =	Contribution margin /sales
		50.00%
2	Break-even point in dollar =	Fixed cost / Contribution margin ratio
		$400,000
3	$22,500
	Increase in sales by $45,000, then contribution margin will increase by $45,000 x 50% = $22,500
	Fixed cost having no change, so net operating income will increase $22,500
4
a	Degree of operating leverage =	contribution margin / net operating income
		$1,040,000 / $840,000
		1.238
b	If sales increase by 20% next year, net operating income would increase by 24.76% (20% x 1.238)