Question

Jen & Berry’s sold 100,000 pints of ice cream last month according to the following contribution format income statement

Total Per Unit

SALES    $330,000    $3.30

VARIABLE COSTS 200,000 2.00

CONTRIBUTION MARGIN $ 130,000 $ 1.30

FIXED COSTS 50,000

NET INCOME $ 80,000

A competing company, Un-Friendly’s, also sold 100,000 pints of ice cream last month according to the following contribution format income statement:

Total Per Unit

SALES $255,000 $2.55

VARIABLE COSTS 100,000 1.00

CONTRIBUTION MARGIN $ 155,000 $ 1.55

FIXED COSTS 75,000

NET INCOME $ 80,000

Both companies sold the same amount of ice cream and had the same Net Income but have different price and cost structures. Jen & Berry’s uses higher quality ingredients (variable cost) and charges a higher price than its competitor. Un-Friendly’s spends more on advertising (fixed cost) and sells at a lower price than Jen & Berry’s.

1. Using last month’s income statements on page 2, calculate the Operating Leverage for each company.
2. If next month’s sales increased by 10% for both companies, would the Net Income for both companies once again be equal or would one company have higher profits than the other? Briefly explain.
3. If next month’s sales decreased by 10% for both companies, would the Net Income for both companies once again be equal or would one company have higher profits than the other? Briefly explain.
4. Using last month’s income statements on page 2, calculate the break-even point in units (pints of ice cream) for each company.

Answer 1

Operating leverage = Contribution Margin/Net Operating income

Jen & Berry = 130,000/80,000 = 1.625

Un-friendly = 155000/80,000 = 1.9375

Change in operating income = Change in Sales*Operating leverage

When sales increases by 10%, Un-friendly will have higher profits because its operating leverage is higher, hence its operating income will increase by a higher %

When sales decreases by 10%, Jen & Berry will have higher profits because its operating leverage is lower, hence its operating income will decrease by a lower %

Break even point = Fixed costs/Contribution Margin per unit

Jen& Berry = 50,000/1.30

= 38,461.54 pints

Un-friendly = 75000/1.55

= 48,387.10 pints