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 Variable expenses Contribution margin Fixed expenses Net operating income $ 2,000,000 1,000,000 1,000,000 180,000 $ 820,000 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 60,000 units and $4,800,000, 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 11%. 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 14% reduction in the selling price, combined with a $61,000 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 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 $1.60 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 $820,000 net operating income as last year?

Answer 1

Feather Friends, Inc. Requirement 1 80 Sales price Less: variable expenses Contribution margin 40 40 100% 50% 50% Requirement 2 Breakeven point in sales dollars = Fixed Expenses / Contribution margin ratio = 180000 / 0.50 = 360000 Requirement 3 $60,000 increased sales x 0.50 CM ratio = $30,000 increased contribution margin. Sin costs will not change, net operating income should also increase by $30,000. Requirement 4a. Degree of Operating leverage = Contribution Margin / Net Operating Income = 1000000 / 820000 = 1.22 Requirement 4b. 1.22 x 11% = 13.42% increase in net operating income. Net Operating income after the 11% increase in sales will be $820,000 + $820,000 * 13.42% = $880,000 * 1.1342 = $998,096 Requirement 5a. Contribution income Statement Last Year: Proposed: 25000 units 31250 units Amount Per Unit Amount Per Unit Sales 2000000 80 2150000 68.8 Less: variable expenses 1000000 40 1250000 40 Contribution margin 1000000 40 900000 28.8 Less: fixed expenses 180000 241000 Net operating income 820000 659000 25,000 units + 25,000 units x 0.25 = 31,250 units $80.00 - $80 x 14% = $68.8 $180,000 + 61,000 increase in advertising = $241,000 Changes should be made Requirement 6. 1200000 Expected total contribution margin: 25,000 units x 1.25 x $38.40 per unit* Present total contribution margin: 25,000 units x $40.00 per unit Incremental contribution margin, and the amount by which advertising can be increased with net operating income remaining unchanged 1000000 200000 *$80.00 -($40.00 + $1.60) = $38.4