Problem 5-23 CVP Applications; Contribution Margin Ratio: Degree of Operating Le
ID: 2411499 • Letter: P
Question
Problem 5-23 CVP Applications; Contribution Margin Ratio: Degree of Operating Leverage [LO5-1, LO5 3, LO5-4, LO5-5, LO5-8] Feather Friends, Inc., distributes o high-quality wooden birdhouse that sells for $80 per unit Variable expenses are $40.00 per unit, and fixed expenses total $180,000 per year. Its opereting results for last yeor were as follows: Sales Variable expenses Contribution margin Fixed expenses Net operating income s 2,88a,e89 1,900,e88 1,800,880 180,888 S 820,800 Required: Answer each question independently based on the original dote: 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 $55,000 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 12%. Using the degree of cperating 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 11% reduction in the selling price, combined with a $61,000 increase in advertising, would increase this year's unit sales by 25%. e. If the seles manager is right, what would be this year's net operating income if his ideas are implemented? b Do you recommend implementing the sales manager's suggestions? 6 The president dces not want to change the selling price. Instead, he wants to increase the sales commission by $190 per unit He president increase this year's adivertising expense and still earn the seme $820,000 net operating income as last year? that this move. combined with some increase in advertising, would increase this year's sales by 25% How much could theExplanation / Answer
1 Sales price $ 80 100% Variable expenses 40 50% Contribution margin $ 40 50% 2 Dollar sales to break even = Fixed expenses ÷ CM Ratio = 180000 ÷ 0.50 $ 360,000 3 $55,000 increased sales x 0.50 CM ratio = $27,500 increased contribution margin. Because the fixed costs will not change, net operating income should also increase by $27,500. 4a Degree of operating Leverage = Contribution margin ÷ Net operating income = $1,000,000 ÷ $820,000 = 1.22 4b 1.22 x 12% = 14.64% increase in net operating income. In dollars, this increase would be 14.64% x $820,000 = $120,000Approx. 5 Last Year: Proposed: 25,000 Units 31,250 Units Amount Per Unit Amount Per Unit Sales $ 2,000,000 $ 80 $ 2,225,000 $71.20** Variable expenses 1,000,000 40 1,250,000 40 Contribution margin 1,000,000 $ 40 975,000 $10.00 Fixed expenses 180,000 241,000 Net operating income $ 820,000 $ 734,000 *25,000 units + 6,250 units = 31,250 units **$80.00 x 0.89 = $71.20 No, the changes should not be made. 6 Expected total contribution margin: 25,000 units x 1.25 x $38.10 per unit* $ 1,190,625 Present total contribution margin: 25,000 units x $40.00 per unit 1,000,000 Incremental contribution margin, and the amount by which advertising can be increased with net operating income remaining unchanged $ 190,625 *$80.00 - ($40.00 + $1.90) = $11.00