Question

Holly's Ham, Inc. sells hams during the major holiday seasons. During the current year 11,000 hams were sold resulting in $220,000 of sales revenue, $55,000 of variable costs, and $24,000 of fixed costs.If sales increase by $40,000, operating income will increase by:

A) $10,000
B) $20, 000
C) $30, 000
D) None of these answers are correct

Answer 1

Sales revenue = $220,000

Variable costs = $55,000

Fixed costs = $24,000

∴ Operating Income = Gross Income - Operating Expenses

Operating Income = $220,000 - ( $55,000 + $24,000 )

Operating Income = $141,000

∵ Sales increase by $40,000

∴ Variable cost proportion to sales =
`(Variable \: Cost)/(Sales)`

⇒ Variable cost proportion to sales =
`(55000)/(220000)`

⇒ Variable cost proportion to sales = 0.25

Now, the Variable cost would become :

Variable cost(new) = Variable cost(old) + Sales increase × Variable cost proportion to sales

Variable cost(new) = 55000+ 40000 × 0.25

Variable cost(new) = 65000

Fixed Cost will remain the same

∴ Operating Income(new) = Gross Income - Operating Expenses

Operating Income(new) = $260,000 - ( $65,000 + $24,000 )

Operating Income(new) = $171,000

∴Increase in Operating Income is $30,000 ($171,000 - $141,000)

i.e. Option(c) is correct.