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 $160,000 per year. Its operating results for last year were as follows: Rectangular Snip Sales Variable expenses Contribution margin Fixed expenses Net operating income $ 3,240,000 1,620,000 1,620,000 160,000 $ 1,460,000 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 $42,000 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 14%. 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?

Answer 1

1) Contribution Margin Ratio = (Total Contribution Margin/Total Sales)*100

= ($1,620,000/$3,240,000)*100 = 50%

2) Break Even Point in Dollar Sales = Total Fixed Cost/CM ratio

= $160,000/50% = $320,000

3) Net operating income will change by the amount of additional contribution margin on additional sales (as fixed asset remain same).

Increase in Operating Income = Additional Sales*CM Ratio

= $42,000*50% = $21,000

Therefore net operating income increase by $21,000.

4) a) Degree of Operating Leverage = Contribution Margin/Net Operating Income

= $1,620,000/$1,460,000 = 1.11

4) b) Percentage increase in Operating Income = % increase in Sales*Degree of operating Leverage

= 14%*1.11 = 15.54%

Therefore net operating income will increase by 15.54%.