Question

This information is for a volume of 5,000 units.

Sales Revenue                                     $160,000

Variable Costs   ( 70,000)

Contribution Margin $ 90,000

Fixed Costs   (10,000)

Net Income                                         $ 80,000

Using the information above, answer the following questions and show all your calculations:

c) Would this company benefit if it increased fixed costs by $4,000 and decreased variable costs by 5%? Show your calculations to support your response.

d) Calculate the degree of operating leverage for this company, using the original information.

e) Using the DOL you calculated in part (d), what would be the effect on net income if sales increased by 2%?

Answer 1

Answer c :

Particulars	Amount
Sales revenue	$1,60,000
(-) variable cost ($70,000 - 5%)	($66,500)
Contribution margin	$93,500
(-)fixed cost ($10,000 + $4,000)	($14,000)
Net income	$79,500

Therefore , By increasing fixed cost & decreasing the variable cost will result in reduction of net income by $500, so its not benefits the company.

Answer d:

Degree of operating leverage = contribution ÷ net income

= $90,000 ÷ $80,000

= 1.125

Answer e : Using DOL in answer (d) calculating impact on net income if sales increased by 2%.

DOL = (sales revenue - variable cost) ÷ Net income

As we know DOL = 1.125

Sales = $160,000 + 2% = $1,63,200

Variable cost = $70,000

DOL = ($1,63,200 - $70,000) ÷ Net income

Net income = ($1,63,200 - $70,000) ÷ DOL

= $93,200 ÷ 1.125

= $82,844.44

= $82,844 (rounded off)

Conclusion : Net income was increased if sales increased by 2%.