Question

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $80 per unit. Variable expenses are $40.00 per unit, and fixed expenses total $180,000 per year. Its operating results for last year were as follows:

Sales	$	2,160,000
Variable expenses		1,080,000
Contribution margin		1,080,000
Fixed expenses		180,000
Net operating income	$	900,000

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. Assume this year’s unit sales and total sales increase by 41,000 units and $3,280,000, respectively. If the 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 unit sales to increase by 12%. 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 $65,000 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, he wants to increase the sales commission by $2.10 per unit. He thinks that this move, combined with some increase in advertising, would increase this year's unit sales by 25%. How much could the president increase this year's advertising expense and still earn the same $900,000 net operating income as last year?

Answer 1

(1) Contribution Margin Ratio = Contribution/ Sales *100 Contribution Margin Ratio = Sales-Variable Cost/ Sales *100 Contribution Margin Ratio = (80-40)/ 80 *100 Contribution Margin Ratio = 50% (2) Break-even point in dollar sales – Fixed Costs/ Contribution Margin Ratio Break-even point in dollar sales = $ 180,000/ 50% Break-even point in dollar sales = $360,000 (3) Net operating Increase = Increase in sales X CM Ratio Net operating Increase = Increase in sales X CM Ratio Net operating Increase = $ 32,80,000 * 50% Net operating Increase = $ 1,640,000 (4a) Degree of Operating Leverage = Contribution Margin / Net Operating Income Degree of Operating Leverage = 10,80,000/ 900,000 Degree of Operating Leverage = 1.2 Times (4b) % increase in Net operating Income = % increase in sales X Degree of Operating Leverage % increase in Net operating Income = % increase in sales X Degree of Operating Leverage % increase in Net operating Income = 12% X 1.2 % increase in Net operating Income = 12% X 1.2 % increase in Net operating Income = 14.4% (5a) Selling Price per unit = $80.00 - (10% * $80.00) Selling Price per unit = $72 Variable Expense per unit = $40.00 Fixed Expenses = $180,000 + $65,000 Fixed Expenses = $ 245,000 nber of units sold at present = Sales/ Selling Price per Number of units sold at present = $2,160,000/ $80.00 Number of units sold at present = 27,000 Expected Number of units sold = 27,000 +(25% of 27,000) Expected Number of units sold = 33,750 units Income Statement :- Particulars Sales (33750*72) Less: Variable Cost (33750*80) Contribution Margin Less : Fixed Cost Net Income Amount 2,430,000 1,350,000 1,080,000 -245,000 835,000 (5b) No, the manager should not implement these changes as net operating income will decrease by $65,000 ($900,000 - $835,000) (6) Selling Price per unit = $80.00 Variable Expense per unit = $40.00 + $2.10 Variable Expense per unit = $42.10 Let increase in advertising be $x Fixed Expenses = $180,000 + $x Expected Number of units sold = 27,000 + 25% * 27,000 Expected Number of units sold = 33,750 units Net Operating Income = Sales - Variable Expenses - Fixed Expenses Net Operating Income = Selling Price per unit * Number of units sold - Variable Expense per unit * Number of units sold - Fixed Expenses 900,000 = (33750*80)-(33750*42.10)-180000+X 900,000 = (33750*80)-(33750*42.10)-180000+X 900,000 = 1099125+X X = 1099125 - 900000 X = 199125 Increase in advertising expense is $199,125.