Question

Problem 8-1 Performing Basic CVP Analysis (LO1 - CC4; LO2 - CC6, 7, 10)

Stratford Company distributes a lightweight lawn chair that sells for $40 per unit. Variable expenses are $16 per unit, and fixed expenses total $672,000 annually Required: Answer the following independent questions: 1. What is the product's CM ratio? tion margin ratio 2. Use the CM ratio to determine the break-even point in sales dollars. k-even point in sales dollars 3. The company estimates that sales will increase by $115,000 during the coming year due to increased demand. By how much should net operating income increase? n operatin 4. Assume that the operating results for last year were as follows: Sales Less: Variable expenses Contribution margin Less: Fixed expenses Net operating income $1,680,000 672,000 1,008,000 672,000 S 336,000 a. Compute the degree of operating leverage at the current level of sales. (Round your answer to 1 decimal place.)

Answer 1

SOLUTION

1. Contribution margin = Sales price - Variable costs

= $40 - $16 = $24

Contribution margin ratio = Contribution margin / Sales Price *100

= $24 / 40 * 100

= 60%

2. Breakeven point in sales dollar = Fixed Expense / Contribution margin ratio

= $672,000 / 60% = $1,120,000

3. Increase in operating income = Change in sales * Contribution margin ratio

= $115,000 * 60% = $69,000

Net operating income will increase by $69,000.

4. Degree of operating leverage = Contribution margin / Net operating income

= $1,008,000 / $336,000

= 3

Percentage change in operating income =Percentage change in sales * Degree of operating leverage

= 40% * 3 = 120%

Dollar increase in operating income = Percentage change in operating income * Operating income

= 120% * $336,000 = $403,200