Question

Cornerstone Exercise 16.7 (Algorithmic) Degree of Operating Leverage, Percent Change in Profit Ringsmith Company is considering two different processes to make its product—process 1 and process 2. Process 1 requires Ringsmith to manufacture subcomponents of the product in-house. As a result, materials are less expensive, but fixed overhead is higher. Process 2 involves purchasing all subcomponents from outside suppliers. The direct materials costs are higher, but fixed factory overhead is considerably lower. Relevant data for a sales level of 28,000 units follow:     Process 1     Process 2 Sales     $7,336,000     $7,336,000 Varoable expenses     2,464,000     4,200,000      Contribution margin     $4,872,000     $3,136,000 Less total fixed expenses     3,500,000     1,450,130      Operating income     $1,372,000     $1,685,870 Unit selling price     $262     $262 Unit variable cost     $88     $150 Unit contribution margin     $174     $112 Required: 1. Compute the degree of operating leverage for each process. Round your answers to one decimal place. Use the rounded answers in subsequent calculations. Process 1 Process 2 2. Suppose that sales are 20 percent higher than budgeted. By what percentage will operating income increase for each process? Process 1 % Process 2 % What will be the increase in operating income for each system? Round your answers to the nearest dollar. Process 1 $ Process 2 $ What will be the total operating income for each process? Round your intermediate calculations and final answers to the nearest dollar. Use the rounded answers in subsequent calculations. Process 1 $ Process 2 $ 3. What if unit sales are 10 percent lower than budgeted? By what percentage will operating income decrease for each process? Process 1 % Process 2 % What will be the total operating income for each process? Round your answers to the nearest dollar. Process 1 $ Process 2 $

Answer 1

with original data processi sales 7336000 less variable expenses 2464000 contribution margin 4872000 less fixed expenses 3500000 operating profit 1372000 process 2 7336000 4200000 3136000 1450130 1685870 3.6 1. degree og operating leverage process 1 process 2 1.9 suppose 20 % higher than budgeted sales 2.operating income increase by percentage process 1 72% process 2 38% increase in operating income process 1 987840 process 2 640631 total operating income process 1 2359840 process 2 2326501

3 if sales are 10 % lower than budgeted sales percent decrease n operating income process 1 36% process 2 19% total operating income process 1 878080 process 1 1365555 working notes operating leverage = contribution margin / operating profit increase in operating income = change in sales %* operating leverage * original operating profit total operating income = original operating income + increase in operating income percentage increase in income = operating leverage * change in sales % percentage decrease in operating income = operating leverage * change in sales %