Question

Tyrene Products manufactures recreational equipment. One of the company’s products, a skateboard, sells for $36. The skateboards are manufactured in an antiquated plant that relies heavily on direct labour workers. Thus, variable costs are high, totalling $25.20 per skateboard, of which 70% is direct labour cost.

Over the past year the company sold 55,000 skateboards, with the following operating results:

Sales (55,000 skateboards)	$	1,980,000
Variable expenses		1,386,000
Contribution margin		594,000
Fixed expenses		540,000
Net operating income	$	54,000

Management is anxious to maintain and perhaps even improve its present level of income from the skateboards.

Required:

1a.	Compute the CM ratio and the break-even point in skateboards. (Do not round intermediate calculations. Round your answer to the nearest whole number.)

         

1b.	Compute the degree of operating leverage at last year's level of sales. (Round your answer to 2 decimal places.)

         

2.

Due to an increase in labor rates, the company estimates that variable costs will increase by $2.16 per skateboard next year. If this change takes place and the selling price per skateboard remains constant at $36.00, what will be the new CM ratio and the new break-even point in skateboards? (Round your intermediate calculations and the "Contribution margin" answer to 2 decimal places and other answer to the nearest whole number. )

         

3.	Refer to the data in (2) above. If the expected change in variable costs takes place, how many skateboards will have to be sold next year to earn the same net operating income, $54,000, as last year? (Do not round intermediate calculations. Round your answer to the nearest whole number.)

          

4.

Refer again to the data in (2) above. The president has decided that the company may have to raise the selling price of its skateboards. If Tyrene Products wants to maintain the same CM ratio as last year, what selling price per skateboard must it charge next year to cover the increased labor costs? (Do not round intermediate calculations. Round your answer to 2 decimal places. )

         

5.

Refer to the original data. The company is considering the construction of a new, automated plant. The new plant would slash variable costs by 30%, but it would cause fixed costs to increase by 80%. If the new plant is built, what would be the company’s new CM ratio and new break-even point in skateboards? (Round your intermediate calculations and the "Contribution margin" answer to 2 decimal places and other answer to the nearest whole number .)

         

6.	Refer to the data in (5) above.

a.	If the new plant is built, how many skateboards will have to be sold next year to earn the same net operating income, $54,000, as last year? (Do not round intermediate calculations. Round your answer to the nearest whole number.)

         

b-1.	Assume that the new plant is constructed and that next year the company manufactures and sells 55,000 skateboards (the same number as sold last year). Prepare a contribution format income statement. (Input all amounts as positive values except losses which should be indicated by minus sign. )

         

b-2.	Compute the degree of operating leverage. (Round your answer to 2 decimal places.)

         

Answer 1

Answer -

1a. Answer -

Contribution margin ratio = (Contribution margin / Sales) * 100

Contribution margin ratio = ($594000 / $1980000) * 100

Contribution margin ratio = 30%

Units sales to break even = Total fixed cost / contribution per unit

Units sales to break even = $540000 / ($36 - $25.20)

Units sales to break even = $540000 / $10.80

Units sales to break even = 50000 units

1b. Answer -

Degree of operating leverage at last year's level of sales:

Degree of operating leverage = Quantity * (Selling price - Variable cost per unit) / Quantity * (Selling price - Variable cost per unit) - Total fixed cost

Degree of operating leverage = 55000 * ($36 - $25.20) / [55000* ($36 - $25.20)] - $540000

Degree of operating leverage = $594000 / $54000

Degree of operating leverage = 11

2. Answer -

Now, increase in variable cost per unit by $2.16

So, new variable cost per unit = $25.20 + $2.16 = $27.36

Contribution margin per unit = Selling price - Variable cost per unit

Contribution margin ratio = [Contribution margin per unit / Selling price] * 100

Contribution margin ratio = [($36 - $27.36) / $36] * 100

Contribution margin ratio = 24%

Units sales to break even = Total fixed cost / contribution per unit

Units sales to break even = $540000 / ($36 - $27.36)

Units sales to break even = $540000 / $8.64

Units sales to break even = 62500 units

3. Answer -

Here, Desired profit or operating income = $54000

Units to be sold to earn desired profit = (Total fixed cost + Desired profit) / Contribution per unit

Units to be sold to earn desired profit = ($540000 + $54000) / ($36 - $27.36)

Units to be sold to earn desired profit = $594000 / $8.64

Units to be sold to earn desired profit = 68750 units

4. Answer -

Here,

CM ratio = 30%

New variable cost = $27.36

That means, Variable cost is 70% of Sales

So, Selling price = ($27.36 * 100) / 70

Selling price = $39.09

5. Answer -

Here,

Selling price = $36

Variable cost per unit = $25.20

And Total fixed cost = $540000

But, Variable cost slash by 30% and Total fixed cost increase by 80%

Therefore,

New variable cost = $25.20 - ($25.20 * 30%) = $17.64

New total fixed cost = $540000 + ($540000 * 80%) = $972000

So,

Contribution margin per unit = Selling price - Variable cost per unit

Contribution margin ratio = [Contribution margin per unit / Selling price] * 100

Contribution margin ratio = [($36 - $17.64) / $36] * 100

Contribution margin ratio = 51%

Units sales to break even = Total fixed cost / contribution per unit

Units sales to break even = $972000 / ($36 - $17.64)

Units sales to break even = $972000 / $18.36

Units sales to break even = 52941 units

6. Answer -

a.

Here, Desired profit or operating income = $54000

Units to be sold to earn desired profit = (Total fixed cost + Desired profit) / Contribution per unit

Units to be sold to earn desired profit = ($972000 + $54000) / ($36 - $17.64)

Units to be sold to earn desired profit = $1026000 / $18.36

Units to be sold to earn desired profit = 55882 units

b-1. Answer-

Contribution Income Statement
Sales (55000 * $36)	$1980000
Variable expenses (55000 * $17.64)	$970200
Contribution margin	$1009800
Fixed expenses	$972000
Net operating income	$37800

b-2. Answer -

Degree of operating leverage:

Degree of operating leverage = Quantity * (Selling price - Variable cost per unit) / Quantity * (Selling price - Variable cost per unit) - Total fixed cost

Degree of operating leverage = 55000 * ($36 - $17.64) / [55000* ($36 - $17.64)] - $972000

Degree of operating leverage = $1009800 / $37800

Degree of operating leverage = 26.71