Question

Magic realm, incorporated, has developed a new fantasy board game. The company sold 35,200 games last year at a selling price of $62 per game. Fixed expenses associated with the game total $616,000 per year, and variable expenses are $42 per game. Production of the game is entrusted to a printing contractor. Required: 1-a. Prepare a contribution format income statement for the game last year. 1-b. Compute the degree of operating leverage. 2. Management is confident that the company can sell 43,648 games next year (an increase of 8,448 games, or 24%, over last year). Given this assumption: a. What is the expected percentage increase in net operating income for next year? b. What is the expected amount of net operating income for next year? (Do not prepare an income statement; use the degree of operating leverage to compute your answer.)

Answer 1

A contribution format income statement shows the net operating income at $88,000 with a degree of operating leverage at 8. With a projected 24% increase in sales next year, the expected percentage increase in net operating income is 192%, leading to an expected net operating income of $257,280.

Step-by-step explanation:

To answer the student's question, first, let's prepare a contribution format income statement for the game:

• Selling price per game: $62
• Variable expenses per game: $42
• Number of games sold: 35,200

Total Revenue = 35,200 games * $62/game = $2,182,400

Total Variable Expenses = 35,200 games * $42/game = $1,478,400

Contribution Margin = Total Revenue - Total Variable Expenses = $2,182,400 - $1,478,400 = $704,000

Fixed Expenses = $616,000

Net Operating Income = Contribution Margin - Fixed Expenses = $704,000 - $616,000 = $88,000

Next, let's compute the degree of operating leverage at the current level of sales:

Degree of Operating Leverage = Contribution Margin / Net Operating Income = $704,000 / $88,000 = 8

Given that the company expects to increase sales by 24%:

a. Since the degree of operating leverage is 8, the expected percentage increase in net operating income is 24% * 8 = 192%.

b. The expected amount of net operating income for next year would be the current net income of $88,000 increased by 192%, which equals $88,000 * (1 + 1.92) = $257,280.