Question

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $120 per unit. Variable expenses are $60.00 per unit, and fixed expenses total $200,000 per year. Its operating results for last year were as follows:

Sales	$	3,240,000
Variable expenses		1,620,000
Contribution margin		1,620,000
Fixed expenses		200,000
Net operating income	$	1,420,000

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 $44,000 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 18%. 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 12% reduction in the selling price, combined with a $61,000 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 $2.20 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 $1,420,000 net operating income as last year?

Answer 1

1. What is the product's CM ratio?

CM ratio = Contribution / Sale *100

        = $1620000/$3240000 * 100 = 50%

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

Break even point = Fixed cost/CM ratio

         = $200000/50% = $400000

3. If this year's sales increase by $44,000 and fixed expenses do not change, how much will net operating income increase?

Sale Increase = $44000

Operating income increase = $44000 * 50% = $22000

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

Contribution/Operating Income

$1620000/$1420000 = 1.14

4-b. Assume the president expects this year's sales to increase by 18%. Using the degree of operating leverage from last year, what percentage increase in net operating income will the company realize this year?

Percentage Increase in net operating income = Percent of increase in sale * DOL

           = 18 * 1.14 = 20.52%

5a. If the sales manager is right, what would be this year's net operating income if his ideas are implemented?

New Selling price = $120 * 88% = $105.60

New sale in units = 27000 * 125% = 33750 units

Variable cost per unit = $60

Net operating income = Units sold * (SP – VC) – Fixed cost – Advertising cost

              = 33750 * ($105.60 - $60) - $200000 - $61000 = $1278000

5b. If the sales manager's ideas are implemented, how much will net operating income increase or decrease over last year?

Net operating income decrease = $1420000 - $1278000 = $142000

6. The president does not want to change the selling price. Instead, he wants to increase the sales commission by $2.20 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 $1,420,000 net operating income as last year?

New VC pu = $60 + $2.20 = $62.20

Net operating income = Units sold * (SP – VC) – Fixed cost – Advertising cost

$1420000 = 33750 * ($120 - $62.20) - $200000 – Advertising cost

$1420000 = $1950750 - $200000 – Advertising cost

Advertising cost = $330750

Answer 2

Req 1	Product CM Ratio	50.00%
	Note 1:
	CM Ratio = Contribution margin / sales
	Contribution margin	1,620,000
	Divided by sales	3,240,000
	CM Ratio	50.00%
Req 2	Break Even points in sales dollar	400,000
	Note 2:
	Break Even points in sales dollar = Fixed expense/CM Ratio
	Fixed expenses	200,000
	Divided by CM Ratio	50.00%
	Break Even points in sales dollar	400,000
Req 3	Net Operating Income Increase by	2,640,000
	Note 3:
	Effect on income = change in sales * CM Ratio
	Increase in sales	5,280,000
	Multiply by CM Ratio	50%
	Net Operating Income Increase by	2,640,000
Req 4-a	Degree of Operating Leverage	1.14
	Note 4:
	Operating Leverage = Contribution margin/ Net Income
	Contribution Margin	1,620,000
	Divided by Net Income	1,420,000
	Degree of Operating Leverage	1.14
Req 4-b	Net Operating Income(NOI) increase by	20.52%
	Note 5:
	Change in NOI = %age change in sales * operating leverage
	%age change in sales	18%
	Multiply by operating leverage	1.14
	Net Operating Income(NOI) increase by	20.52%
Req 5-a	Contribution Income   statement
		Last Year		Proposed
		27,000	Units	33,750	Units
		Total	Per Unit	Total	Per Unit
	Sales	3,240,000	120.00	3,564,000	105.60
	Less: Variable expense	1,620,000	60.00	2,025,000	60.00
	Contribution margin	1,620,000	60.00	1,539,000	45.60
	Fixed expenses	200,000		261,000
	Net Income	1,420,000		1,278,000
Req 5-b	Net Operating Income Decrease by	(142,000)
Req 6	The amount by which advertising can be increased	330,750
	Note6:
	Contribution margin per unit (Last year)	60.00
	Less: increase in sales comm	(2.20)
	Prposed contribution margin	57.80
	Multiplied by proposed sales after increase	33,750
	Proposed total contribution margin	1,950,750
	Less: Fixed expenses	(200,000)
	Less: Target Income	(1,420,000)
	The amount by which advertising can be increased	330,750