Question

Magic Realm, Inc., has developed a new fantasy board game. The company sold 45,500 games last year at a selling price of $65 per game. Fixed expenses associated with the game total $819,000 per year, and variable expenses are $45 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 57,330 games next year (an increase of 11,830 games, or 26%, over last year). Given this assumption: a. What is the expected percentage increase in net operating income for next year

Answer 1

1.a. Magic Realm

Income Statement

For the year ended December 31, 202x

Sales revenue $2,957,500

Variable costs ($2,047,500)

Contribution margin $910,000

Period costs ($819,000)

Operating income $91,000

1.b. degree of operating leverage = contribution margin / operating income = $910,000 / $91,000 = 10

2.a. a 26% increase in net sales should increase operating income by 26% x 10 (operating leverage) = 260%

total operating income for next year = $91,000 + ($91,000 x 260%) = $327,600