Question

A Cruise line offers nightly dinner cruises departing from several cities on the eastern coast of the United States including​ Charleston, Baltimore, and Alexandria. Dinner cruise tickets sell for $50 per passenger. Live It ​Cruiseline's variable cost of providing the dinner is $20 per​ passenger, and the fixed cost of operating the vessels​ (depreciation, salaries, docking​ fees, and other​ expenses) is $270,000 per month. The​ company's relevant range extends to 14,000

monthly passengers. The breakeven sales are 9,000 tickets sold.

a. Compute the operating leverage factor when the Cruiseline sells 12,000 dinner cruises.   

b. If volume increases by 7​%, by what percentage will operating income​ increase?

c. If volume decreases by 2​%, by what percentage will operating income​ decrease?

Answer 1

a. Contribution margin per unit = Sales - Variable cost = $50 - $20 = $30

Contribution margin for 12,000 dinner cruises = $30 * 12,000 = $360,000

Operating Income = Contribution Margin - FIxed Expenses

Operating Income = $360,000 - $270,000 = $90,000

Operating Leverage = Contribution Margin / Operating Income

Operating Leverage = $360,000/$90,000 = 4 times

Operating leverage of 4 means that a 10% increase in sales will lead to a 40% increase in the profits/operating income.

b. If volume increases by 7%, operating income will increase by 28% (7%*4 times).

Therefore, increase in operating income = $ 25,200 ($90,000 * 28%)

c. If volume decreases by 2%, operating income will decrease by 8% (2%*4 times).

Therefore, decrease in operating income = $ 7,200 ($90,000 * 8%)