Question

Hudson Co. reports the contribution margin income statement for 2019.

HUDSON CO.
Contribution Margin Income Statement
For Year Ended December 31, 2019
Sales (12,000 units at $225 each)	$	2,700,000
Variable costs (12,000 units at $180 each)		2,160,000
Contribution margin	$	540,000
Fixed costs		360,000
Pretax income	$	180,000

1. Compute the company’s degree of operating leverage for 2019.
2. If sales decrease by 4% in 2020, what will be the company’s pretax income?
3. Assume sales for 2020 decrease by 4%. Prepare a contribution margin income statement for 2020.

Answer 1

1 Degree of Opearting Leverage = Contribution / Profit before Tax 540000/180000 3 2 If sales decrease by 4% in 2020, the company's pretax income = Decrease in sales * Operating leverage 4% * 3 Decrease in companies pretax income = 12% 3 Contribution margin income statement Amount in $ 2592000 2073600 Sales (2700000-4%) Variable cost Contribution (20%) Fixed cost Pretax income 518400 360000 158400 Notes variable costs are expenses that change directly and proportionally to the changes in volume of sales. Fixed cost includes expenses that remain constant for a period of time irrespective of the level of outputs.