Answer:
a. Degree of operating leverage is <u>1.23</u>; and Percentage increase in net income is <u>23.37%</u>.
b. Therefore, this year's net operating income would be <u>$636,000</u> if the sales manager's ideas are implemented.
Explanation:
a. Assume the president expects this year's sales to increase by 19%. Using the degree of operating leverage from last year, what percentage increase in net operating income will the company realize this year?
The degree of operating leverage (DOL) refers to a metric used to gauge the amount by which the operating income of a firm will change as a result of a change in its sales. DOL can be calculated as follows:
Degree of operating leverage = contribution margin / net income = 960,000 / 780,000 = 1.23
From the DOL, the percentage increase in net income can can be determined as follows:
Percentage increase in net income = Degree of operating leverage * Expected percentage increase in net income = 1.23 * 19% = 23.37%
b. If the sales manager is right, what would be this year's net operating income if his ideas are implemented?
Note: This required part b is not complete. The complete requirement is therefore presented as follows:
The sales manager is convinced that a 13% reduction in the selling price, combined with a $72,000 increase in advertising, would increase this year's unit sales by 25%. If the sales manager is right, what would be this year's net operating income if his ideas are implemented?
The answer to par b is now provided as follows:
Initial sales in unit = Initial sales / Initial selling price = $1,920,000 / $80 = 24,000 units
This year's sales in unit = Initial sales in unit * (100% + percentage increase in sales) = 24,000 * 125% = 30,000 units
This year's sales = This year's sales in unit * [Old selling price * (100% - expected percentage fall in selling price)] = 30,000 * [$80 * (100% - 13%)] = $2,088,000
This year's operating income can now be determined as follows:
Feather Friends, Inc.
Income Statement (Variable Costing)
For this year
<u>Particulars Amount ($) </u>
Sales 2,088,000
Variable expense (30,000 * $40) <u> (1,200,000) </u>
Contribution margin 888,000
Fixed expense (180,000 + 72,000) <u> (252,000) </u>
Net operating income <u> 636,000 </u>
Therefore, this year's net operating income would be <u>$636,000</u> if the sales manager's ideas are implemented.
