Question

Ringsmith Company is considering two different processes to make its product-process 1 and process 2. Process 1 requires Ringsmith to manufacture subcomponents of the product in-house. As a result, materials are less expensive, but fixed overhead is higher. Process 2 involves purchasing all subcomponents from outside suppliers. The direct materials costs are higher, but fixed factory overhead is considerably lower. Relevant data for a sales level of 37,000 units follow: Sales Variable expenses Contribution margin Less total fixed expenses Operating income Unit selling price Unit variable cost Unit contribution margin Process 1 $9,546,000 3,663,000 $5,883,000 3,736,925 $2,146,075 $258 $99 $159 Process 2 $9,546,000 5,328,000 $4,218,000 1,434,320 $2,783,680 $258 $144 $114 Required: 1. Compute the degree of operating leverage for each process. Round your answers to one decimal place. Use the rounded answers in subsequent calculations. Process 1 Process 2 2. Suppose that sales are 20 percent higher than budgeted. By what percentage will operating income increase for each process? Process 1 % Process 2 What will be the increase in operating income for each system? Round your answers to the nearest dollar. Process 1 $ Process 2

Answer 1

Computation of degree of operating leverage for each process Degree of operating leverage in = sales - Variable cost 87.5 Sales-variable cost-finced Ost Process - = $ 95,46000-$3663000 $ 25,46000 - $36,63000 - $3736925 B 56,83000 do $2146075 2.7

for process - 2 $95,46000 - $53,28000 $05, 46000 - $53, 28000 - $114,34320 = $42, 18000 $ 2782680 = 1.5 Leif sales are 20% higher than budgeted process Process 2 Sales & lootues $10/14, 55,200 s 114,55,200 ovariable expenses ($3663000) ($ 5328000) contribition 2 1 & 27, 92, 2001 $61,27,200 o fized cost T83736925. ($14.84,320) operating ancome & 4055,275 $46,92,880 Increase in operating ancouse $1909roo & 1909 200 go Ancrease an operating ancouse 88.961 G8.59%. to $ 1909200 X 100) $1909200 xlo) ( a $2783680 &2146075

than 3) if cenit sales are 107. lower budgeted Budgeted units - 37000 90% of above - 33,300 Process - 2 33, 300 process -1 Sales units 33,300 onit contribution. margin $159 Total contribution (85294700 - fixed costs $37369257 operating ancome $ 1557575 decrease Gol.. operating Acouse 28588300 $ 114. 37.96200 $1434320) & 2361880 -$421.800 - 27.4 p.it - 15.15.1 op of decrease an operating ancome -588300 x100) $2146075 $421 800 xloo 278380