Question

Stratford Company distributes a lightweight lawn chair that sells for $60 per unit. Variable expenses are $24 per unit, and fixed expenses total $777,600 annually.

Required:

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 sales dollars.

      

3.	The company estimates that sales will increase by $85,000 during the coming year due to increased demand. By how much should net operating income increase?

    

4.	Assume that the operating results for last year were as follows:

Sales		$	2,160,000
Less: Variable expenses			864,000
Contribution margin			1,296,000
Less: Fixed expenses			777,600
Net operating income		$	518,400

a.	Compute the degree of operating leverage at the current level of sales. (Round your answer to 1 decimal place.)

           

b.	The president expects sales to increase by 60% next year. By how much should net operating income increase?

             

5-a.

Refer to the original data. Assume that the company sold 38,000 units last year. The sales manager is convinced that a 10% reduction in the selling price, combined with a $144,000 increase in advertising expenditures, would increase annual unit sales by 30%. Prepare two contribution format income statements: one showing the results of last year’s operations, and one showing what the results of operations would be if these changes were made. (Do not round intermediate calculations. Round "Per Unit" answers to 2 decimal places.)

      

5-b.	Would you recommend that the company do as the sales manager suggests?
	Yes No

6.

Refer to the original data. Assume again that the company sold 38,000 units last year. The president feels that it would be unwise to change the selling price. Instead, he wants to increase the sales commission by $2 per unit. He thinks that this move, combined with some increase in advertising, would double annual unit sales. By how much could advertising be increased with profits remaining unchanged?

    

Answer 1

Contribution per unit = Sales Value - Variable cost

60 - 24 = 36

(1) Contribution Margin Ratio = Contribution*100/Sales

36*100/60 = 60%

(2) Break even Sales in Dollars = Fixed Cost/ Contribution Margin Ratio

777600/60% = 1296000

(3) Increase in net operating income because of increase in Sales-

85000*60% = 51000

(4)(a) Degree of Operating Leverage = Contribution/profit

1296000/518400 = 2.5

(b) Contribution Margin Ratio= 1296000*100/2160000 = 60%

Increase in sales if it increase by 60% = 2160000*60% = 1296000

increase in net operating profit is sales increase by 60%-

1296000*60% = 777600.

(5)(a)

	Last Year	Next Year
Units	38000	49400(38000+30%)
Sales	2280000(38000*60)	2667600(49400*54)
Variable Cost	912000	1185600
Contribution Margin	1368000	1482000
Fixed Cost	777600	777600
Advertisement		144000
Net Operating Income	590400	560400
Result		Decreased by 30000

(5)(b) No

(6)

	Before Change	After Change
Units	38000	76000
Sales	2280000(38000*60)	4560000(76000*60)
Variable Cost	912000	1976000(76000*26)
Contribution Margin	1368000	2584000
Fixed Cost	777600	777600
Advertisement		x
Net Operating Income	590400	590400
Result		Decreased by 30000

2584000-(777600+x) = 590400

x = 1216000.