Question

Margin of Safety and Operating Leverage

Medina Company produces a single product. The projected income statement for the coming year is as follows:

Sales (60,000 units @ $23.00)	$1,380,000
Total variable cost	372,600
Contribution margin	$ 1,007,400
Total fixed cost	973,820
Operating income	$ 33,580

Required:

1. Compute the break-even sales dollars.
$

2. Compute the margin of safety in sales dollars.
$

3. Compute the degree of operating leverage.

4. Compute the new operating income if sales are 20% higher than expected.

Answer 1

Contribution margin ratio=Contribution margin/Sales

=(1007400/1380000)=0.73

1.Breakeven sales=Fixed cost/Contribution margin ratio

=(973820/0.73)=$1,334,000

2.Margin of safety=Total sales-Breakeven sales

=(1,380,000-1,334,000)=$46,000

3.DOL=Contribution margin/Operating income

=(1007400/33580)=30

4.Increase in sales would bring an increase in Contribution margin.Hence

New Contribution margin=$1007400*1.2=$1208880

Less:Fixed cost=$973820

New operating income=$235060

NOTE:Variable cost per unit and Total fixed cost do not change with change in units.