Question

Cove’s Cakes is a local bakery. Price and cost information follows:

Price per cake	$	14.01
Variable cost per cake
Ingredients		2.31
Direct labor		1.05
Overhead (box, etc.)		0.16
Fixed cost per month	$	4,405.80

Required:

1. Calculate Cove’s new break-even point under each of the following independent scenarios:

a. Sales price increases by $1.80 per cake.

b. Fixed costs increase by $540 per month.

c. Variable costs decrease by $0.28 per cake.

d. Sales price decreases by $0.70 per cake.

2. Assume that Cove sold 440 cakes last month. Calculate the company’s degree of operating leverage.

3. Using the degree of operating leverage, calculate the change in profit caused by a 12 percent increase in sales revenue.

Answer 1

1. Break even point is calculated as follows:

Formula of break even: Fixed cost / contribution per unit

Where contribution per unit= Sales price p.u. - Variable cost p.u.

A) Break even point= $4,405.80 / ( $15.81 -$ 3.52 )

= 358.5 units or 358 units

In amounts= 358 units*$15.81

=$ 5,659.98

B) Break even point= $4,945.80 / ($14.01 - $3.52)

=471.5 units or 471 units  

In amounts = 471 units* $14.01

$6,598.71

C) Break even point= $ 4,405.80 / ($14.01 - $3.24)

=409 units

In amounts = 409 units*$14.01

=$5,730.09

D) Break even point = $4,405.80 / ($13.31 - $3.52)

= 450 units

In amounts = 450 units*$13.31

=$5,989.5

Note: we can also calculate the Break even point in amounts by multiplying break even point in units with selling price

2. Degree of operating leverage on sale of 440 cakes = Sales - Variable cost / Sales - variable cost - fixed cost

= (440 cakes*$14.01) - (440 cakes*$3.52) / (440 cakes*$14.01) - (440 cakes*$3.52) - $4,405.80

= ($6,164.4 - $1,548.8) / ($6,164.4 -$1,548.8-$4,405.80)

=$4,615.6 / $209.8

=21.99

3. Profit before increase of 12 percent revenue (taking 440 cakes as base) = sales - variable cost - fixed cost

= $209.8

When sales revenue increased by 12%

Increased sales = 493 units

Sales value=493*$14.01

=$6,906.93

Increased variable cost= 493units*$3.52

=$1,735.36

Fixed cost= $4,405.80

Therefore, profit= $765.77

Increased profit= $765.77 - $209.8

=$555.97