Question

Thad Morgan, a motorcycle enthusiast, has been exploring the possibility of relaunching the Western Hombre brand of cycle that was popular in the 1930s. The retro-look cycle would be sold for $12,000 and at that price, Thad estimates 600 units would be sold each year. The variable cost to produce and sell the cycles would be $9,000 per unit. The annual fixed cost would be $1,350,000.

a. What is the break-even in unit sales?

b.  What is the margin of safety in dollars?

c. What is the degree of operating leverage? (Round your answer to 2 decimal places.)

Thad is worried about the selling price. Rumors are circulating that other retro brands of cycles may be revived. If so, the selling price for the Western Hombre would have to be reduced to $10,400 to compete effectively. In that event, Thad would also reduce fixed expenses to $1,107,000 by reducing advertising expenses, but he still hopes to sell 600 units per year.

d. What would the net operating income be in this situation? (Negative amount should be indicated by a minus sign.)

Answer 1

a) BEP (In units ) = Fixed Cost/(SP - VC)
Unit sales	600	units
Selling price per unit	$12,000	per unit
Variable expenses per unit	$9,000	per unit
Contribution margin	$3,000	per unit
Fixed expenses	$1,350,000
a) BEP (In units ) = Fixed Cost/(SP - VC)
BEP (units) = $1,350,000 /(12000 - 9000)	450.00	units
b) Margin of safety in dollars
Sales (at the budgeted volume of 600 units)  = 600 x 12000	$ 7,200,000.00
Break-even sales (at 450 units) (450 x 12000)	$ 5,400,000.00
Margin of safety (in dollars)	$ 1,800,000.00
c)
Contribution margin = $3000 x 600	$ 1,800,000.00
Fixed expenses	$1,350,000
Net operating Income	$450,000
Degree of operating leverage = Contribution margin ÷ Net operating income
Degree of operating leverage = 1800000 ÷ 450000	4.00
d)
Sales (600 x $10,400)	$ 6,240,000.00
Variable expenses (600 x 9000)	$ 5,400,000.00
Contribution margin	$    840,000.00
Fixed expenses	$ 1,107,000.00
Net operating loss	$  (267,000.00)