Question

Casas Modernas of Juarez, Mexico, is contemplating a major change in its cost structure. Currently, all of its drafting work is performed by skilled draftsmen. Rafael Jiminez, Casas' owner, is considering replacing the draftsmen with a computerized drafting system. However, before making the change, Rafael would like to know the consequences of the change, since the volume of business varies significantly from year to year. Shown below are CVP income statements for each alternative. Manual System Computerized System Sales Variable costs Contribution margin Fixed costs Net Income $1,560,000 1,248,000 312,000 72,000 $240,000 $1,560,000 624,000 936,000 696,000 $240,000 Determine the degree of operating leverage for each alternative. (Round answers to 2 decimal places, e.g. 1.25.) Degree of Operating Leverage Manual System Computerized System Calculate the increase in Net Income for each alternative if sales increased by $110,000 Increase in Net Income Manual System Computerized System Which alternative would produce the higher net income? Calculate the margin of safety ratio. (Round ratios to 2 decimal places, e.g. 0.25.) Margin of Safety ratio Manual System Computerized System Using the margin of safety ratio, determine which alternative could sustain the greater decline in sales before operating at a loss

Answer 1

The answer to the above mentioned questions is below in form of images :-

Degree of operating Loverage formula = Degree of operating leverage (DOL) Controbution Operating Income for the given two systems, DOL would be :- Manual System Computerized System DOL = Contribution Operating Income -DOL = Contribution Operating Income - $ 312,000 $240,000 $9362000 $ 240,000 DOL = 1.3 DOL = 3.9

Now, current sales lovel is $1,560,000 For Manual System, if sales increased and computerized system by $ 110,000 The increase in net income would be Manual System | Computerized System Increased Variable sales Costs $ 1,670,000 1,248,000 $1,670,000 624,000 Contribution Margin Fixed Costs 422000 72000 1,046,000 696,000 $ 350,000 $350,000 Net Income (increased) Both of the alternatives would produce the same net Income. Even though the same sale amount is increased.

- Formula for margin of Safety (mos) mos = Current Sales lovel - Breakeven - Point X loc Current Sales Level. First of all the Break even point. Manual System Computerized system BEP - Fixed Costs Contribution I BEP - Fixed Costs Contribution