Question

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $20 per unit. Variable expenses are $8 per unit, and fixed expenses total $180,000 per year. Its operating results for last year were as follows: Sales Variable expenses Contribution margin Fixed expenses Net operating income $ 400,000 160,000 240,000 180,000 $ 60,000 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 $75,000 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 20%. 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 10% reduction in the selling price, combined with a $30,000 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? 6. The president does not want to change the selling price. Instead, de wants to increase the sales commission by $1 per unit. He thinks that this move, combined with some increase in advertising, would increase this year's sales by 25%. How much could the president increase this year's advertising expense and still earn the same $60,000 net operating income as last year? Complete this question by entering your answers in the tabs below.

Answer 1

1. Contribution Margin ratio = Contribution margin / Sales = 240,000 / 400,000 = 60%

2. Break even point = Fixed expenses/ Contribution margin = 180,000 / 60%= 300,000

3. Net operating income will increase by $45,000 [ 105,000 - 60,000]

Sales	475,000	[400,000+75000]
Less: Variable costs	190000	[475,000*40%]
Contribution	285,000
Less: Fixed expenses	180,000
Net operating income	105,000

4a. Degree of operating leverage = Contribution / Net operating income = 240,000 / 60,000 = 4

4b. Net operating income increases by = 20% *4 = 80%

5a. Net operating income = $40,000

Workings:

No of units sold currently = 400000/20 = 20,000

Increase in sales = 20,000 *125% = 25,000 units

Sales	450,000	[25000*18]
Less: Variable costs	200000	[25000*8]
Contribution	250,000
Less: Fixed expenses	210,000
Net operating income	40,000

  

5b. Net operating income will decrease by $20,000

6. Increase in advertising cost = $35000 [ 215000 - 180,000]

New variable cost = 8+1 = 9 per unit

Sales	500,000	[25000*20]
Less: Variable costs	225000	[25000*9]
Contribution	275,000
Less: Fixed expenses	215,000
Net operating income	60,000