Question

4. month: The following is Robin Corporation's contribution format income statement for the last Sales $1,500,000 Variable expenses $500,000 Contribution margin $1,000,000 Fixed expenses $600,000 Net operating income $400,000 The company has no beginning or ending inventories and produced and sold 50,000 units during the month. Required: A. What is the company's contribution margin ratio? B. What is the company's break even in units? If sales increased by 1000 units, by how much should net operating income increase? C. D. How many units would the company have to sell to attain target profits of $500,000? E. What is the company's margin of safety in dollars? F. What is the company's degree of operating leverage?

Answer 1

A. Contribution margin ratio is calculated as contribution margin divided by sales:

Contribution margin ratio = Contribution margin / Sales

Contribution margin ratio = $1,000,000 / $1,500,000

Contribution margin ratio = 0.67 or 67%

B. Break-even in units can be calculated as fixed expenses divided by contribution margin per unit:

Break-even in units = Fixed expenses / Contribution margin per unit

Contribution margin per unit = Contribution margin / Units sold

Contribution margin per unit = $1,000,000 / 50,000

Contribution margin per unit = $20

Break-even in units = $600,000 / $20

Break-even in units = 30,000 units

If sales increased by 1000 units, the company's net operating income would increase by the contribution margin on those units:

Contribution margin on 1000 units = 1000 units x $20 per unit = $20,000

C. Units to attain target profit can be calculated as follows:

Target profit = Fixed expenses + Target profit / Unit contribution margin

Target profit = $600,000 + $500,000 / $20

Target profit = $1,100,000 / $20

Target profit = 55,000 units

D. Margin of safety in dollars can be calculated as the difference between actual sales and break-even sales, multiplied by the contribution margin ratio:

Margin of safety = (Actual sales - Break-even sales) x Contribution margin ratio

Break-even sales = 30,000 units x $20 per unit = $600,000

Margin of safety = ($1,500,000 - $600,000) x 0.67

Margin of safety = $900,000 x 0.67

Margin of safety = $603,000

E. Degree of operating leverage (DOL) can be calculated as follows:

DOL = Contribution margin / Net operating income

DOL = $1,000,000 / $400,000

DOL = 2.5

This means that a 1% change in sales would result in a 2.5% change in net operating income.

F. The degree of operating leverage (DOL) can also be calculated as follows:

DOL = Total contribution margin / Net operating income

Total contribution margin = Sales - Variable expenses

Total contribution margin = $1,500,000 - $500,000

Total contribution margin = $1,000,000

DOL = $1,000,000 / $400,000

DOL = 2.5

Therefore, the company's degree of operating leverage is 2.5.