Question

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $80 per unit. Variable expenses are $40.00 per unit, and fixed expenses total $180,000 per year. Its operating results for last year were as follows:

Sales	$	2,160,000
Variable expenses		1,080,000
Contribution margin		1,080,000
Fixed expenses		180,000
Net operating income	$	900,000

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 $52,000 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 13%. 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 14% reduction in the selling price, combined with a $74,000 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 $1.70 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 $900,000 net operating income as last year?

Answer 1

Answer 1.

Number of units sold = Sales / Selling Price per unit
Number of units sold = $2,160,000 / $80.00
Number of units sold = 27,000

Contribution Margin Ratio = Contribution Margin / Sales
Contribution Margin Ratio = $1,080,000 / $2,160,000
Contribution Margin Ratio = 50%

Answer 2.

Breakeven in dollar sales = Fixed Expenses / Contribution Margin Ratio
Breakeven in dollar sales = $180,000 / 0.50
Breakeven in dollar sales = $360,000

Answer 3.

Increase in Sales = $52,000

Increase in Net Operating Income = Increase in Sales * Contribution Margin Ratio
Increase in Net Operating Income = $52,000 * 50%
Increase in Net Operating Income = $26,000

Answer 4-a.

Degree of Operating Leverage = Contribution Margin / Net Operating Income
Degree of Operating Leverage = $1,080,000 / $900,000
Degree of Operating Leverage = 1.20

Answer 4-b.

% Increase in Sales = 13.00%

Degree of Operating Leverage = % Increase in Net Operating Income / % Increase in Sales
1.20 = % Increase in Net Operating Income / 13.00%
% Increase in Net Operating Income = 15.60%

Answer 5.

Selling Price per unit = $80.00 - 14% * $80.00
Selling Price per unit = $68.80

Variable Expense per unit = $40.00

Fixed Expenses = $180,000 + $74,000
Fixed Expenses = $254,000

Number of units sold = 27,000 + 25% * 27,000
Number of units sold = 33,750

Income Statement Sales (33,750 * $68.80) Variable expenses (33,750 * $40.00) Contribution margin Fixed expenses Net operating income $ $ $ $ $ 2,322,000 1,350,000 972,000 254,000 718,000

No, the manager should not implement these changes as net operating income will decrease by $182,000 ($900,000 - $718,000)

Answer 6.

Selling Price per unit = $80.00

Variable Expense per unit = $40.00 + $1.70
Variable Expense per unit = $41.70

Let increase in advertising be $x

Fixed Expenses = $180,000 + $x

Number of units sold = 27,000 + 25% * 27,000
Number of units sold = 33,750

Net Operating Income = Sales - Variable Expenses - Fixed Expenses
Net Operating Income = Selling Price per unit * Number of units sold - Variable Expense per unit * Number of units sold - Fixed Expenses
$900,000 = $80.00 * 33,750 - $41.70 * 33,750 - ($180,000 + $x)
$900,000 = $2,700,000 - $1,407,375 - $180,000 - $x
$x = $212,625

Increase in advertising expense is $212,625