Use the CM ratio to determine the break-even point in sales dollars.1 answer below »

Basics of CVP Analysis Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $20 per unit. Variable costs are $8 per unit, and fi xed costs total $180,000 per year.

Required: Answer the following independent questions: 1. What is the product’s CM ratio? 2. Use the CM ratio to determine the break-even point in sales dollars. 3. Due to an increase in demand, the company estimates that sales will increase by $75,000 during the next year. By how much should net operating income increase (or net loss decrease) assuming that fixed costs do not change? 4. Assume that the operating results for last year were: Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $400,000 Variable expenses . . . . . . . . . . . . . . . . . . . 160,000 Contribution margin . . . . . . . . . . . . . . . . . . 240,000 Fixed expenses . . . . . . . . . . . . . . . . . . . . . 180,000 Net operating income . . . . . . . . . . . . . . . . $ 60,000 a. Compute the degree of operating leverage at the current level of sales. b. The president expects sales to increase by 20% next year. By what percentage should net operating income increase? 5. Refer to the original data. Assume that the company sold 18,000 units last year. The sales manager is convinced that a 10% reduction in the selling price, combined with a $30,000 increase in advertising, would cause annual sales in units to increase by one-third. Prepare two contribution format income statements, one showing the results of last year’s operations and one showing the results of operations if these changes are made. Would you recommend that the company do as the sales manager suggests? 6. Refer to the original data. Assume again that the company sold 18,000 units last year. The president does not want to change the selling price. Instead, he wants to increase the sales commission by $1 per unit. He thinks that this move, combined with some increase in advertising, would increase annual sales by 25%. By how much could advertising be increased with profits remaining unchanged? Do not prepare an income statement; use the incremental analysis approach.

Sep 15 2021 07:49 AM

1 Approved Answer

Navin J
answered on
September 17, 2021

4.5
Ratings,(20 Votes)

1) Contribution Margin Ratio is calculated as contribution
per unit divided by the selling price per unit. It is the excess of sales over
the variable cost per unit and it helps to find the profitability over the
variable costs of the company. Answer 1: In $ Contribution Margin Ratio A Selling Price per unit 20 B Variable Cost per unit 8 A-B=C Contribution Per unit 12 C/A Contribution Margin Ratio 60% 2) Break Even Point ( Sales Dollar) is the point of
sales at which the contribution equals the fixed cost of the company. At first
we calculate the break even point in units which is required for break even and
then we multiply it with the selling price per unit to get the desired result. Answer 2: D Fixed Cost 180000 D/C= E Break Even in units 15000 E X A Thus break even in sales dollar 300000 3) If the sales are going to increase by $ 75000 in
the next year then keeping the fixed cost constant the total income of the
company is going to increase by Contribution Margin of increased sales. That is
60% of 75000= $ 45000 Answer 4: Sales 400000 Variable Expenses 160000 Contribution Margin 240000 Fixed Expenses 180000 Net Operating Income 60000 a) Degree of Operating Leverage = EBIT/ SALES 60000/400000 15% b) On increase in sales by 20% the net income will increase as follows: Year `1 Year 2 Sales 400000 480000 Variable Expenses 160000 192000 Contribution Margin 240000 288000 Fixed Expenses 180000 180000 Net Operating Income 60000 108000 (108000-60000)/60000 80% Answer5: Year1`...

2 Sales (units ) 18000 24000 an increase by 6000 units Selling Price per unit 20 18 a reduction in price by 2 per unit Variable Cost per unit 8 Sales in Amount 360000 432000 Variable Cost in Amount 144000 174000 an increase by 30000 Contribution 216000 258000 Fixed Cost 180000 180000 keeping constant EBIT 36000 78000 Thus as suggested by the sales manager the company should opt for the new policy of adding in advertising costs since it is increasing the overall profits of the company. Answer 6: Year1` Year 2 Sales (units ) 18000 22500 an increase by 25% Selling Price per unit 20 20 Variable Cost per unit 8 9 an increase of commision of $ 1 Contribution Per unit before advertising 12 11 Contribution Amount 216000 247500 Extra Advertising Cost which company can incur 31500 Using incremental analysis approach we can see the following: Increase in sales units 4500 (18000*25%) Increase in Sales Amount 90000 (4500*20) Increase in Variable costs before advertising 58500 Increase in Contribution before advertising 31500 (90000-58500) Thus additional advertising expense which company can bear 31500

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