Question

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $40 per unit. Variable expenses are $20.00 per unit, and fixed expenses total $180,000 per year. Its operating results for last year were as follows:

Sales	$	1,000,000
Variable expenses		500,000
Contribution margin		500,000
Fixed expenses		180,000
Net operating income	$	320,000

Required:

Answer each question independently based on the original data:

1. What is the product's CM ratio?

2. Use the CM ratio to determine the break-even point in dollar sales.

3. If this year's sales increase by $52,000 and fixed expenses do not change, how much will net operating income increase?

4-a. What is the degree of operating leverage based on last year's sales?

4-b. Assume the president expects this year's sales to increase by 10%. Using the degree of operating leverage from last year, what percentage increase in net operating income will the company realize this year?

5. The sales manager is convinced that a 11% reduction in the selling price, combined with a $68,000 increase in advertising, would increase this year's unit sales by 25%.

a. If the sales manager is right, what would be this year's net operating income if his ideas are implemented?

b. If the sales manager's ideas are implemented, how much will net operating income increase or decrease over last year?

6. The president does not want to change the selling price. Instead, he wants to increase the sales commission by $1.70 per unit. He thinks that this move, combined with some increase in advertising, would increase this year's sales by 25%. How much could the president increase this year's advertising expense and still earn the same $320,000 net operating income as last year?

Answer 1

	Contribution Margin Income Statement
		Total	Per Unit
	Sales(25000 units)	$                  1,000,000	$                         40.00
	Variable expenses	$                     500,000	$                         20.00
	Contribution Margin	$                     500,000	$                         20.00
	Fixed expenses	$                     180,000
	Net Operating Income	$                     320,000
1	Contribution Margin Ratio($20/$40)	50%
2	Break-even Point in Dollars($180,000/50%)	$                     360,000
3	If the Sales increases by $52,000 then Contribution Margin will increase by $26,000($52,000*50%)
	And since the Fixed Cost does not change hence the Operating Income will also increase by $26,000
4.a	Degree of operating leverage =Contribution Margin / Net Income
	Degree of operating leverage for last year =$500,000 / $320,000 =1.5625
4.b	If the Sales increases by 10% then based on Degree of operating leverage the Net operating income will also increase by 15.625% or 15.63%
5.a	Contribution Margin Income Statement
		Total	Per Unit
	Sales(31250 units)	$                  1,112,500	$                         35.60
	Variable expenses	$                     625,000	$                         20.00
	Contribution Margin	$                     487,500	$                         15.60
	Fixed expenses($180,000+$68,000)	$                     248,000
	Net Operating Income	$                     239,500
5.b	Net Operating Income has Decreased by $80,500($320,000-$239,500)
6	Required Selling Price per unit	$                         40.00
	Required Variable expense per unit($20+$1.70)	$                         21.70
	Required Contribution Margin per unit	$                         18.30
	Required Sales in units(25,000*1.25)	31250
	Required Contribution Margin(31250*$18.30)	$                     571,875
	Less:Required Net Income	$                     320,000
	Required Fixed Costs	$                     251,875
	Less:Original Net Income	$                     180,000
	Adverstising cost required to make	$                       71,875