Question

A rug company is holding a​ 2-week carpet sale at a local warehouse store. They plan to sell carpets for $500 each. The company will purchase the carpets from a local distributor for $350 ​each, with the option to return any unsold units for a full refund. The warehouse offered two payment alternatives for the use of space - A fixed payment of $5,100 for the sale period or 10​% of total revenues earned during the sale. The rug company will not have any other costs.

Calculate the breakeven point in units for​ each payment alternatives

Begin by determining the formula to calculate the breakeven point in units.

Number of units to breakeven = _____________ / ______________

At what level of revenues will the rug company earn the same operating income under either​ option?

For what range of unit sales will they prefer option​ 1?

For what range of unit sales will they prefer option​ 2?

Determine the degree of operating leverage at sales of 102 units for the two rental options.

Answer 1

Let's calculate the breakeven point in units first

Number of units to breakeven = Fixed cost / Contribution per unit

Contribution per unit = Sellng price per unit - Variable cost per unit

Particulars	Option 1	Option 2
Fixed cost	$ 5100	$ 0
Selling price per unit	$ 500	$500
Variable cost per unit	$ 350	$ 400
Contribution per unit	$ 150	$ 100
Breakeven point in units	34 units	0 Units

Level of sales unit to earn same operating income   = Difference in fixed cost / Difference in contribution margin

   = 5100 / 50

  = 102 units

Level of revenue to earn same operating income  = $ 500 *102

= $50100

Option 1 will be preferred if unit sales are above 102 units.

if sales are above 102 units, income earned is more in option 1

Option 2 will be preferred if unit sales are below 102 units.

If sales are below 102 units, income earned is more in option 2.

Degree of operating leverage = Contribution margin / Net operating income

Particulars	Option 1	Option 2
Number of units sold	102	102
Contribution per unit	150	100
Contribution margin	15300	10200
Net operating income	10200	10200
Degree of operating leverage	1.5	1

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