Question

PLEASE NOTE!!!! I ONLY NEED HELP WITH QUESTION #8 A&B. PLEASE SEE THE ANSWER TO QUESTION 7 IN ORDER TO SOLVE.

Kate and Claire, recent college graduates, are unable to find suitable jobs in their field of accounting. However, each has been involved with a small business of their own for the last several years, and have been doing very well. Kate is a talented seamstress, and has designed a line of fashionable blazers that are selling for $500/each. Kate remains shocked at how fast the orders are coming in, and wonders if this could be something big.   Claire also has a small but growing business. She manufactures synthetic leather belts that are selling for $50/each, and is similarly experiencing strong consumer interest. A few large retailers have started to place orders with both girls, and both are struggling to keep up with demand. Kate and Claire are wondering if they should combine their lines and start building the business together, since there is a high amount of overlap among their customers, and they could likely achieve some synergies by combining their marketing and customer service efforts. The belts go very well with the blazers. With a solid knowledge of their accounting basics, both have kept very thorough cost and marketing data. So they decided to pull it all together and analyze it.

Kate’s blazers – manufacturing data

	# of Blazers	Total Manufacturing Costs
2019	400	$140,000
2018	350	130,000
2017	310	122,000
2016	240	108,000
2015	275	115,000
2014	250	106,000

Kate’s blazers – marketing data

	# of Blazers	Total Marketing Costs
2019	400	$60,000
2018	350	55,000
2017	310	51,000
2016	240	44,000
2015	275	47,500
2014	250	45,000

Claire’s belts – manufacturing data

	# of Belts	Total Manufacturing Costs
2019	1,700	$66,500
2018	1,400	56,000
2017	1,100	45,500
2016	1,000	42,000
2015	1,200	49,000
2014	900	38,500

Claire’s belts – marketing data

	# of Belts	Total Marketing Costs
2019	1,700	$11,500
2018	1,400	10,000
2017	1,100	8,500
2016	1,000	8,000
2015	1,200	9,000
2014	900	7,500

7. Income statement

1. Prepare a forecasted income statement (to the operating income line) for Kate and Claire, assuming they sell 700 blazers and 2,500 belts, and assuming the 5% cost increase for the blazer (variable and fixed production costs) and the additional $30,000 combined fixed costs.
2. How would you suggest Kate and Claire divide the operating profit?

QUESTION 7 ANSWER:

According to our forecasted income statement, the operating profit could be divided in ratio of individual for each one of them. The ratio would thus be: 50,000:10275

Forecasted Income Statement
	Blazers	Belts	Total
Total sales	$350,000	$125,000	$475,00
Less:Variable cost
Manufacturing costs	$147,000	$91,875	$238,875
Marketing costs	$70,000	$12,500	$82,500
Total variable costs	$217,000	$104,375	$321,375
Contribution margin	$133,000	$20,625	$153,625
Fixed costs
Common fixed costs			30,000
Manufacturing costs	$63,000	$7,350	$70,350
Marketing costs	$20,000	$3,000	$23,000
Total Fixed costs	$83,000	$10,350	$123,350
Net income	$50,000	$10,275	$30,275

8. Degree of Operating Leverage

1. Calculate the degree of operating leverage, with the same assumptions as Question #7.
2. What does the DOL tell Kate and Claire? Do you think they should consider promotional events? Why or why not?

Answer 1

Answer:

Degree of Operating leverage:

Operating Leverage is a financial efficiency ratio used to measure the sensitivity or changes in company's operating income to its sales.This Financial ratio shows how the change in the company sales will effect its operating income.

The degree of operating leverage is a method used to quantify a companies operating risk, this risk arises due to fixed and variable cost.

High Operating Leverage = Fixed cost is higher than Variable cost, this will generate higher profits from each incremental sale.

Low Operating Leverage = Fixed cost is lower than Variable cost, this will generate lower profits from each incremental sale.

Formula used to calculate Degree of Operating Leverage:

changeinoperatingincome changein sales
OR
Contribution Margin Operating Profit

Contribution = Sales - Variable Cost

(a) The Degree of operating leverage with the same assumptions as question 7

Formula used for calculation :

Contribution Margin Operating Profit

where the contribution taken $153625 and Operating Profit $30275

hence, The Degree of Operating Leverage is = 5.07

153625 30275

(b) Degree of Operating leverage of Kate and Claire:

Particulars	Kate	Claire
Contribution	$ 133000	$ 20625
Fixed common cost	$ 24886	$ $ 5144
Manufacturing Cost	$ 63000	$ 7350
Marketing Cost	$ 20000	$ 3000
Total Fixed Cost	$ 107886	$ 15494
Net Income	$ 25114	$ 5161
Degree of Operating Leverage (Rounded off)	5.30	4.0

Yes, I think they require promotional events as the degree of Operating leverage of Claire is Low which shows variable cost is higher than fixed cost compare to Kate . There Combine Degree of Operating Leverage is 5.07 which is lower than individual Kate. To increase the sales of Claire the promotional events should be organised.