Question

1.       Feather Friends, Inc., distributes a high- quality wooden birdhouse that sells for $ 20 per unit. Variable expenses are $ 8 per unit, and fixed expenses total $ 180,000 per year.

DO ONLY QUESTION 3-6

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 $ 75,000 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 400,000

Variable expenses . . . . . . . . . . . . . . . . . . . . . . 160,000

Contribution margin . . . . . . . . . . . . . . . . . . . . .240,000

Fixed expenses . . . . . . . . . . . . . . . . . . . . . . . .   180,000

Net operating income . . . . . . . . . . . . . . . . . . .. $ 60,000

a.       Compute the degree of operating leverage at the current level of sales.

b.       The president expects sales to increase by 20% next year. By what percentage should net operating income increase?

5. Refer to the original data. Assume that the company sold 18,000 units last year. The sales manager is convinced that a 10% reduction in the selling price, combined with a $30,000 increase in advertising, would increase annual unit sales by one- third. Prepare two contri-bution format income statements, one showing the results of last year’s operations and one showing the results of operations if these changes are made. Would you recommend that the company do as the sales manager suggests?

6. Refer to the original data. Assume again that the company sold 18,000 units last year. The president does not want to change the selling price. Instead, he wants to increase the sales commission by $ 1 per unit. He thinks that this move, combined with some increase in advertising, would increase annual sales by 25%. By how much could advertising be increased with profits remaining unchanged? Do not prepare an income statement; use the incremental analysis approach.

Answer 1

Answer 1.
Contribution Margin Ratio = Contribution / Sales
Contribution = $20 (SP) - $8 (Variable Expense)
Contribution = $12
Contribution Margin Ratio = $12 / $20
Contribution Margin Ratio = 60%
Answer 2.
BEP (In $ Sales) = Fixed Cost / Contribution Margin Ratio
BEP (In $ Sales) = $180,000 / 60%
BEP (In $ Sales) = $300,000
Answer 3.
Net Operating Income Increased by = $75,000 X 60% (Contribution Margin Ratio)
Net Operating Income Increased by = $45,000
Answer 4-a.
Degree of Operating Leverage = Contribution / Net Operating Income
Degree of Operating Leverage = $240,000 / $60,000
Degree of Operating Leverage = 4
Answer 4-b.
Net Operating Increases by = 20% (increase in sales) x 4 (DOL)
Net Operating Increases by = 80%