Question

Magic Realm, Inc., has developed a new fantasy board game. The company sold 48,500 games last year at a selling price of $61 per game. Fixed expenses associated with the game total $873,000 per year, and variable expenses are $41 per game. Production of the game is entrusted to a printing contractor. Variable expenses consist mostly of payments to this 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 60,625 games next year (an increase of 12,125 games, or 25%, 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

1a.

Contribution format income statement for the game last year

Sales ( 48,500 games × $61) $2,958,500

Less Variable Expenses ( 48,500 games × $41) ($1,988,500)

Contribution $970,000

Less Fixed Costs ($873,000)

Net Income / (loss) $97,000

1b. 10.00

2a. 250%

2b. $339,500

Step-by-step explanation:

Contribution Income Statement : Shows Separately the Variable Costs and Fixed Cost

Degree of operating leverage = Contribution / EBIT

= $970,000 / $97,000

= 10.00

Increase in net operating income = Degree of operating leverage × Percentage Increase in Sales

= 10.00 × 25%

= 250%

Expected amount of net operating income = Last Year`s net operating income × 3.5

= $97,000 × 3.5

= $339,500