Please show the step-by-step to get answer. PROBLEM 3–28 Graphing; Incremental A
ID: 2418598 • Letter: P
Question
Please show the step-by-step to get answer. PROBLEM 3–28 Graphing; Incremental Analysis; Operating Leverage [LO 3–2, LO 3–4, LO 3–5, LO 3–6, LO 3–8] Teri Hall has recently opened Sheer Elegance, Inc., a store specializing in fashionable stockings. Ms. Hall has just completed a course in managerial accounting, and she believes that she can apply certain aspects of the course to her business. She is particularly interested in adopting the cost volume- profit (CVP) approach to decision making. Thus, she has prepared the following analysis: Sales price per pair of stockings . . . . . . . . . . . . . . . . . $2.00 Variable expense per pair of stockings . . . . . . . . . . . . 0.80 Contribution margin per pair of stockings . . . . . . . . . . $1.20 Fixed expense per year: Building rental . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $12,000 Equipment depreciation . . . . . . . . . . . . . . . . . . . . . 3,000 Selling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,000 Administrative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,000 Total fixed expense . . . . . . . . . . . . . . . . . . . . . . . . . . . $60,000 Required: 1. How many pairs of stockings must be sold to break even? What does this represent in total dollar sales? 2. Prepare a CVP graph or a profit graph for the store from zero pairs up to 70,000 pairs of stockings sold each year. Indicate the break-even point on the graph. 3. How many pairs of stockings must be sold to earn a $9,000 target profit for the first year? 4. Ms. Hall now has one full-time and one part-time salesperson working in the store. It will cost her an additional $8,000 per year to convert the part-time position to a full-time position. Ms. Hall believes that the change would bring in an additional $20,000 in sales each year. Should she convert the position? Use the incremental approach. (Do not prepare an income statement.) 5. Refer to the original data. Actual operating results for the first year are as follows: Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $125,000 Variable expenses . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000 Contribution margin . . . . . . . . . . . . . . . . . . . . . . . . . 75,000 Fixed expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000 Net operating income . . . . . . . . . . . . . . . . . . . . . . . . $ 15,000 a. What is the store’s degree of operating leverage? b. Ms. Hall is confident that with some effort she can increase sales by 20% next year. What would be the expected percentage increase in net operating income? Use the degree of operating leverage concept to compute your answer.
Explanation / Answer
1. break even sales (in units) = fixed cost / contribution per unit
= 60,000 /1.2
= 50,000 pairs of stocking
Sales at break even in dollars = break even sales (in units) * sale price per unit
= 50,000 * 2
= $100,000
2. Profit / loss = contribution - fixed cost
sales(in units) contribution fixed cost profit/loss
zero zero 60,000 60,000 loss
20,000 20,000*1.2= 24,000 60,000 36,000 loss
50,000 50,000*1.2= 60,000 60,000 no profit no loss
70,000 70,000*1.2= 84,000 60,000 24,000 profit
3. contribution per unit * number of units sold - Fixed cost = profit
1.2 * number of units sold - 60,000 = 9,000
number of units sold = 9,000+60,000/1.2
number of units sold = 57,500 pairs of stocking
4. contribution margin ratio = contribution / sale price per per pair
= 1.2/20 = .60
additional contribution = contribution margin ratio * sales = .6*20,000 = $12,000
additional fixed cost = $8,000
additinal income $12,000-$8,000= $4,000
yes she should convert the position
5. % degree of operating leverage = %change in operating income / %change in sales
sales in dollars for 70,000 pair = 70,000*2= $140,000 , operating income = $24,000 (part 2 )
%change in operating income = 24,000-15,000/15,000= 60%
% change in sales = 140,000-125,000/125,000= 12%
% degree of operating leverage = 60%/12%= 5
So we are now given that % increase in sales = 20%
So % increase in operating income = % increase in sales * degree of operating leverage
= 20% * 5 = 100%