Question

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $40 per unit. Variable expenses are $20.00 per unit, and fixed expenses total $180,000 per year. Its operating results for last year were as follows: Sales Variable expenses Contribution margin Fixed expenses Net operating income $ 1,120,000 560,000 560,000 180,000 $ 380,000 Required: Answer each question independently based on the original data: 1. What is the product's CM ratio? 2. Use the CM ratio to determine the break-even point in dollar sales. 3. If this year's sales increase by $48,000 and fixed expenses do not change, how much will net operating income increase? 4-a. What is the degree of operating leverage based on last year's sales? 4-b. Assume the president expects this year's sales to increase by 19%. Using the degree of operating leverage from last year, what percentage increase in net operating income will the company realize this year? 5. The sales manager is convinced that a 13% reduction in the selling price, combined with a $72,000 increase in advertising, would increase this year's unit sales by 25%. a. If the sales manager is right, what would be this year's net operating income if his ideas are implemented? b. If the sales manager's ideas are implemented, how much will net operating income increase or decrease over last year? 6. The president does not want to change the selling price. Instead, he wants to increase the sales commission by $2.10 per unit. He thinks that this move, combined with some increase in advertising, would increase this year's sales by 25%. How much could the president increase this year's advertising expense and still earn the same $380,000 net operating income as last year?

Answer 1

Req 1 :
CM ratio = Contribution margin / Sales = 560000 / 1120000	50%

Req 2 :
Break-even point in dollar sales = Fixed expenses / CM ratio = 180000 / 50%	360000

Req 3 :
Increase in net operating income = ( Increase in sales * CM ratio ) - Increase in fixed expense = ( 48000 * 50% ) - 0	24000

Net operating income

increases

by

24000

Req 4A :
Degree of operating leverage = Contribution margin / Net operating margin = 560000 / 380000	1.47

Req 4B :
Degree of operating leverage = % change in net operating income / % change in sales
1.47 = % change in net operating income / 19%
% change in net operating income = 1.47 * 19%	28%

Net operating income increase by

28%

Req 5 :
Last year's unit sales = Sales / Selling price = 1120000 / 40	28000
After changes :
Selling price = Current selling price * ( 1 - % reduction ) = 40 * ( 1 -13% )	34.80
Fixed expenses = Current fixed expenses + Increase in advertising expense = 180000 + 72000	252000
Unit sales = Last year's unit sales * ( 1 + % increase ) = 28000 * ( 1 + 25% )	35000

a.
Sales ( 35000 * 34.80 )	1218000
(-) Variable expenses ( 35000 * 20 )	700000
Contribution margin	518000
(-) Fixed expenses	252000
Net operating income	266000
b.
Last year's net operating income	380000
(-) This year's budgeted net operating income	266000
Decrease in net operating income	114000

6.
After change :
Unit sales = Last year's unit sales * ( 1 + % increase ) = 28000 * ( 1 + 25% )	35000
Variable expense per unit = Current variable expense per unit + Increase in sales commission per unit = 20 + 2.10	22.10
Net operating income = Unit sales * ( Selling price - Variable cost per unit ) - Fixed expenses
380000 = 35000 * ( 40 - 22.10 ) - Fixed expense
380000 = 626500 - Fixed expense
Fixed expense = 626500 - 380000	246500

The amount by which advertising can be increase is = Fixed expenses after changes - Current fixed expenses = 246500 - 180000

66500