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 ZYour answer has been saved and sent for grading. See Gradebook for score details. 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 1.3 Computerized System 3.0

Answer 1

Contribution margin ratio of Manual system = Contribution margin / Sales

= 312,000/1,560,000

= 20%

Increase in net income of Manual system = Increase in sales x contribution margin ratio

= (110,000 x 20%)

= $22,000

Contribution margin ratio of Computerized l system = Contribution margin / Sales

= 936,000/1,560,000

= 60%

Increase in net income of Computerized l system = Increase in sales x contribution margin ratio

= (110,000 x 60%)

= $66,000

	Increase in Net Income
Manual System	$22,000
Computerized System	$66,000

Computerized system alternative would produce the higher net income.

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