Question

Problem 11-25 Effects of operating leverage on profitability Franklin Training Services (FTS) provides instruction on the use of computer software for the em ployees of its corporate clients. It offers courses in the clients' offices on the clients' equipment. The only major expense FTS incurs is instructor salaries; it pays instructors $6,000 per course taught. FTS recently agreed to offer a course of instruction to the employees of Novak Incorporated at a price of $700 per student. Novak estimated that 20 students would attend the course. Base your answers on the preceding information.

Answer 1

(a) Fixed cost ; because the cost of instructor is $6,000 per course taught irrespective of the number of students attending the course.

(b) $8, 000 ;

Revenue from joining of 20 students = $700 * 20 i.e, $14,000

Cost of instructor = $6,000

Profit = $14,000 - $6,000 i.e, $8,000

(c) $9,400 , 17.5% ;

Revenue from 22 students = 22 * $700 i.e. $15,400

Profit = $15,400 - $6,000 i.e, $9,400

% change in profit = ($9,400 - $8,000) / $8,000

= 17.5%

(d) $6,600 , 17.5% ;

Revenue from 18 students = 18 * $700 i.e. $12,600

Profit = $12,600 - $6,000 i.e, $6,600

% change in profit = ($6,600 - $8,000) / $8,000

= -17.5%

(e) A 10% shift in enrollment has resulted in 17.5% shift in the profits because of the instructor cost. The cost of instructor is fixed and will result in increased deviation from profit (either positive or negative) in case of change in number of students.

(f) Variable Cost ; because the instructor will be paid as per the number of students that would be taught by him.

(g) $8,000 ;

Enrollment fees per student = $700

Instructor fees per student = $300

Profit per student = $400

Profit from 20 students = 20 * $400 i.e $8,000

(h) $8,800 , 10% ;

Profit from 22 students = 22 * $400 i.e. $8,800

% change in profit = ($8,800 - $8,000) /$8,000

= 10%

(i) $7,200 , 10% ;

Profit from 18 students = 18 * $400 i.e. $7,200

% change in profit = ($7.200 - $8,000) /$8,000

= -10%

(j) The only cost charged against the revenue is instructor cost, which is $300 per student. It is a variable cost and changes proportionately will the number of students resulting in proportional increase / decrease in profit with the change in number of students.

(k) Workbook cost in Total = 20 workbooks @ $30 each i.e. $600

Total cost for workbook will remain constant irrespective of number of students enrolled.

Workbook cost per students = Total workbook cost / Number of students

Workbook cost per students (18 students) = $600 / 18 i.e, $33.33

Workbook cost per students (20 students) = $600 / 20 i.e, $30

Workbook cost per students (22 students) = $600 / 22 i.e, $27.27

(l) Fixed cost ; because the cost of $30 includes the cost for duplication and royalty fees, it will not affect the cost if FTS wants to print extra workbooks because increased number of student enrollment and if the student enrollment is less than the number of workbooks printed, the excess workbooks have to be destroyed.

(m) As the workbooks are subject to royalty, the excess of workbooks over the number of students enrolled are to be destroyed. This increases the risk of holding the inventory.

(n) Just-in-time inventory system will reduce the cost of inventory because then there will be no need to destroy the excess inventory because of low level of enrollment of number of students.