Question

Question 1. Carmel Rugs is holding a 2-week carpet sale at Jean's Club, a local warehouse store. Carmel Rugs plans to sell carpets for $1,000 each. The company will purchase the carpets from a local distributor for $400 each, with the privilege of returning any unsold units for a full refund. Jean's Club has offered Carmel Rugs two payment alternatives for the use of space. Option 1: A fixed payment of $17,400 for the sale period Option 2: 20% of total revenues earned during the sale period Assume Carmel Rugs will incur no other costs. Required: Calculate the breakeven point in units for (a) option 1 and (b) option 2. At what level of revenues will Carmel Rugs earn the same operating income under either option? 1. 2. For what range of unit sales will Carmel Rugs prefer option 1? For what range of unit sales will Carmel Rugs prefer option 2? Calculate the degree of operating leverage at sales of 87 unit for the two rental options. Briefly explain and interpret your answer to requirement 3. а. b. 3. 4.

Answer 1

1a. Break even point in units = fixed cost/ contribution per unit

= 17400/600(1000-400)

= 29 units

1b.let the number of units sold be x

Break even point in units = 20% of 1000x/ 600

= 0.33x

2. Profit = contribution- fixed costs

600× X - 17400 = 600 × X - 20/100 × 1000X

600X-17400 = 600X - 200X

200 X = 17400

X = 87

at the level of 87 units it earns same operating income under both options

a. At the sales units of break even point that is 29 units it can prefer option 1

b.at the sales units of break even point that is 0.33X units it can prefer option 2

3 . Degree of operating leverage = contribution/ ebit

   (Option 1) = 600×87/34800

= 1.5 times

EBIT = contribution- fixed costs

(Option 2 ) = 600×87/41760(52200-20%)

= 1.25 times

4.option 1 has higher operating leverage than option 2 due more fixed costs which has higher business risk