Question

Exercise 5-15 (Algo) Operating Leverage (LO5-1, LO5-8] Magic Realm, Inc., has developed a new fantasy board game. The company sold 17,200 games last year at a selling price of $68 per game. Fixed expenses associated with the game total $258,000 per year, and variable expenses are $48 per game. Production of the game is entrusted to a printing contractor. Variable expenses consist mostly of payments to this contractor. Required: 1-a. Prepare a contribution format income statement for the game last year. 1-b. Compute the degree of operating leverage. 2. Management is confident that the company can sell 20,984 games next year (an increase of 3,784 games, or 22%, over last year). Given this assumption: a. What is the expected percentage increase in net operating income for next year? b. What is the expected amount of net operating income for next year? (Do not prepare an income statement; use the degree of operating leverage to compute your answer.)

Answer 1

1-a.

	Total	Per unit
Sales	$1,169,600	$68
Variable expense	$825,600	$48
Contribution margin	$344,000	$20
Fixed expense	$258,000
Net operating income	$86,000

1-b.

Degree of operating leverage:

= $344,000 / $86,000

= 4

2)

a.

Net operating income increases by:

= 4 X 22%

= 88%

b.

Total expected net operating income:

= $86,000 + ($86,000 X 88%)

= $161,680