Question

Exercise 5-15 Operating Leverage [LO5-1, LO5-8] Magic Realm, Inc., has developed a new fantasy board game. The company sold 16,200 games last year at a selling price of $65 per game. Fixed expenses associated with the game total $243,000 per year, and variable expenses are $45 per game. Production of the game is entrusted to a printing contractor. Variable expenses consist mostly of payments to this contractor. Required: 1-a. Prepare a contribution format income statement for the game last year. 1-b. Compute the degree of operating leverage. 2. Management is confident that the company can sell 20,736 games next year (an increase of 4,536 games, or 28%, over last year). Given this assumption: a. What is the expected percentage increase in net operating income for next year? b. What is the expected amount of net operating income for next year? (Do not prepare an income statement; use the degree of operating leverage to compute your answer.)

Answer 1

Answer to Requirement 1-a:

Selling Price per unit = $65.00
Variable Cost per unit = $45.00
Fixed Expenses = $243,000
Number of Units Sold = 16,200

Magic Realm, Inc. Contribution Income Statement Total Sales $ 1,053,000 $ Variable expenses $ 729,000 $ Contribution margin $ 324,000 $ Fixed expenses $ 243,000 Net operating income $ 81,000 Per Unit 65.00 45.00 20.00

Answer to Requirement 1-b:

Degree of Operating Leverage = Contribution Margin / Net Operating Income
Degree of Operating Leverage = $324,000 / $81,000
Degree of Operating Leverage = 4.00

Answer to Requirement 2-a:

Degree of Operating Leverage = % Increase in Net Operating Income / % Increase in Sales
4.00 = % Increase in Net Operating Income / 28.00%
% Increase in Net Operating Income = 112.00%

Answer to Requirement 2-b:

Expected Net Operating Income = Net Operating Income + Increase in Net Operating Income
Expected Net Operating Income = $81,000 + 112% * $81,000
Expected Net Operating Income = $90,720