Question

Casas Modernas of Juarez, Mexico, is contemplating a major change in its cost structure. Currently, all of its drafting work is performed by skilled draftsmen. Rafael Jiminez, Casas’ owner, is considering replacing the draftsmen with a computerized drafting system. However, before making the change, Rafael would like to know the consequences of the change, since the volume of business varies significantly from year to year. Shown below are CVP income statements for each alternative.

		Manual System		Computerized System
Sales		$1,740,000		$1,740,000
Variable costs		1,392,000		696,000
Contribution margin		348,000		1,044,000
Fixed costs		108,000		804,000
Net income		$240,000		$240,000

(a)

Determine the degree of operating leverage for each alternative. (Round answers to 2 decimal places, e.g. 1.25.)

		Degree of Operating Leverage
Manual System
Computerized System

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Attempts: 0 of 3 used

Using multiple attempts will impact your score.

10% score reduction after attempt 2

(b)

Calculate the increase in Net income for each alternative if sales increased by $123,000.

		Increase in Net Income
Manual System		$
Computerized System		$

Which alternative would produce the higher net income ?

eTextbook and Media

Attempts: 0 of 3 used

Using multiple attempts will impact your score.

10% score reduction after attempt 2

(c)

Calculate the margin of safety ratio. (Round ratios to 2 decimal places, e.g. 0.25.)

		Margin of Safety ratio
Manual System
Computerized System

Using the margin of safety ratio, determine which alternative could sustain the greater decline in sales before operating at a loss.

Answer 1

(a)

Determine the degree of operating leverage for each alternative. (Round answers to 2 decimal places, e.g. 1.25.)

		Degree of Operating Leverage
Manual System		348000/240000 = 1.45
Computerized System		1044000/240000 = 4.35

(b)

Calculate the increase in Net income for each alternative if sales increased by $123,000.

		Increase in Net Income
Manual System		$123000*20% = 24600
Computerized System		$123000*60% = 73800

Which alternative would produce the higher net income ?

Computerized sytem

(c)

Calculate the margin of safety ratio. (Round ratios to 2 decimal places, e.g. 0.25.)

		Margin of Safety ratio
Manual System		(1740000-540000)/1740000 = 0.69
Computerized System		(1740000-1340000)/1740000 = 0.23

Break even sales Manual = 108000/.20 = 540000; Break even sales Computerized = 804000/.60 = 1340000