Question

Cove’s Cakes is a local bakery. Price and cost information follows: Price per cake $ 14.21 Variable cost per cake Ingredients 2.16 Direct labor 1.08 Overhead (box, etc.) 0.17 Fixed cost per month $ 3,348.00 Required: 1. Calculate Cove’s new break-even point under each of the following independent scenarios: a. Sales price increases by $1.80 per cake. b. Fixed costs increase by $470 per month. c. Variable costs decrease by $0.37 per cake. d. Sales price decreases by $0.40 per cake. 2. Assume that Cove sold 325 cakes last month. Calculate the company’s degree of operating leverage. 3. Using the degree of operating leverage, calculate the change in profit caused by a 7 percent increase in sales revenue.

Answer 1

1. a. Break even point with increase in sales price - 266 units

b. Break even point with increase in fixed costs - 354 units

c. Break even point with decrease in variable cost - 300 units

d. Break even point with decrease in sales price - 322 units

2. Degree of operating leverage 21.67

3. The change in profit caused by a 7 % increase in revenue is 3.1 times

Step-by-step explanation:

Computation of break even point with an increase in sales price by $ 1.80 per cake

Sales price $ 14.21 + $ 1.80 = $ 16.01

Materials $ 2.16

Direct Labor $ 1.08

Indirect Material $ 0.17

Variable Costs per unit $ 3.41

Contribution margin $ 12.60

Fixed costs $ 3,348

Break even points $ 3,348/ $ 12.60 266 units

Computation of break even point with an increase in fixed costs by $ 470

Sales price $ 14.21 = $ 14.21

Materials $ 2.16

Direct Labor $ 1.08

Indirect Material $ 0.17

Variable Costs per unit $ 3.41

Contribution margin $ 10.80

Fixed costs ( $ 3,348 + 470) $ 3,718

Break even points $ 3,718/ $ 10.18 354 units

Computation of break even point with a decrease in variable costs by $ 0.37 per unit

Sales price $ 14.21 = $ 14.21

Materials ( $ 2.16 - $ 0.37) $ 1.79

Direct Labor $ 1.08

Indirect Material $ 0.17

Variable Costs per unit $ 3.04

Contribution margin $ 11.17

Fixed costs $ 3,348

Break even points $ 3,348/ $ 11.17 units 300 units

Computation of break even point with a decrease in sales price by $ 0.40 per cake

Sales price $ 14.21 -0.40 $ 13.81

Materials $ 2.16

Direct Labor $ 1.08

Indirect Material $ 0.17

Variable Costs per unit $ 3.41

Contribution margin $ 10.40

Fixed costs $ 3,348

Break even points $ 3,348/ $ 10.40 units 322 units

Computation of degree of operating leverage

Sales - 325 cakes at $ 14.21 per cake $ 4,618

Variable costs 325 cakes * $ 3.41 per cake $ 1,108

Contribution margin $ 3,510

Fixed costs $ 3,348

Operating income $ 162

Degree of operating leverage $ 3510/ $ 162 = 21.67 times

Computation of change in income by a change in sales revenue

Degree of operating leverage - 21.67 times

The change in net income is calculated by the formula

Degree in operating leverage = Change in operating income /change in sales

21.67/7= Change in Operating income

Change in operating income = 3.1 times