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Homework answers / question archive / Feather Friends, Inc
Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $80 per unit. Variable expenses are $40.00 per unit, and fixed expenses total $160,000 per year. Its operating results for last year were as follows:
Sales $ 2,160,000 Variable expenses 1,080,000 1,080,000 Contribution margin Fixed expenses 160,000 Net operating income $ 920,000
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. Assume this year's unit sales and total sales increase by 51,000 units and $4,080,000, respectively. If the 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 unit sales to increase by 11%. 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 14% reduction in the selling price, combined with a $65,000 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 $2.40 per unit. He thinks that this move, combined with some increase in advertising, would increase this year's unit sales by 25%. How much could the president increase this year's advertising expense and still earn the same $920,000 net operating income as last year?
1.Computation of Contribution Margin Ratio:
Contribution Margin Ratio = Contribution Margin / Sales
= 1,080,000 / 2,160,000
Contribution Margin Ratio = 50%
2.Computation of Breakeven Point (In Value):
Breakeven Point (In Value) = Fixed Cost / Contribution Margin Ratio
= 160,000 / 50%
Breakeven Point (In Value) = $320,000
3.Computation of Increase in Net Operating Income:
We know that variable cost is 50% of selling price
If there is no change in Fixed Cost, then
Increase in Profit = Increase in Sales - Increase in Variable expenses
= $4,080,000 - $2,040,000 ($4,080,000*50%)
Increase in Net Operating Income = $2,040,000
4-a. Computation of Degree of Operating Leverage based on last year's sales:
Degree of Operating Leverage = Contribution / Earnings before Interest and Tax (EBIT)
= $1,080,000 / 920,000
Degree of Operating Leverage = 1.17
4-b. Computation of Increase in Net Operating Income:
Degree of Operating Leverage = % Change in EBIT / % Change in sales
1.174 = % Change in EBIT / 11%
Increase in Net Operating Income = 1.174*11% = 12.91%
5-a.
Current sales units = $2,160,000 / 80 = 27,000 units
Current selling price = $80 per unit
Proposed selling price = $80 * (1-14%) = $68.80 per unit
Variable cost per unit = $40
New contribution margin per unit = $68.80 - $40 = $28.80 per unit
Proposed sales volume = 27,000 * (1+25%) = 33,750 units
Proposed fixed after considering additonal expenditure on advertising = $160,000 + $65,000 = $225,000
Net Operating income if sales manager ideas are implemented = Contribution Margin - Fixed Costs
= (33,750 * $28.80) - $225,000 = $747,000
5-b.
Decrease in Net Operating Income = $920,000-$747,000 = $173,000
As net operating income decreases, therefore sales manager suggestion should not be implemented.
6:
Selling price per unit = $80
New variable cost after sales commission = $40 + $2.40 = $42.40 per unit
New contribution margin per unit = $80 - $42.40 = $37.60 per unit
New sales volume = 27,000 * 125% = 33,750 units
New contribution margin = 33,750 * $37.60 = $1,269,000
Target net operating income = $920,000
Maximum fixed cost that company could afford = $1,269,000 - $920,000 = $349,000
Existing fixed cost = $160,000
The amount by which advertising expense can be increased is = $349,000 - $160,000 = $189,000
