1. Case Study

2. The margin of safety can be calculated by:
A) Sales − (Fixed expenses/Contribution margin ratio).
B) Sales − (Fixed expenses/Variable expense per unit).
C) Sales − (Fixed expenses + Variable expenses).
D) Sales − Net operating income. A

3. Hopi Corporation expects the following operating results for next year:
Sales $400,000
 Margin of safety $100,000 
Contribution margin ratio 75% 
Degree of operating leverage 4
What is Hopi expecting total fixed expenses to be next year?
A) $75,000
B) $100,000
C) $200,000
D) $225,000 D

4. Ans: D Solution: Current sales - Breakeven sales = Margin of safety
Substituting the given information into the above equation, we will have:
$400,000 − Breakeven sales = $100,000
Breakeven sales = $300,000
Breakeven sales = Fixed expenses ÷ Contribution margin ratio
$300,000 = Fixed expenses ÷ 0.75
Fixed expenses = $225,000

5. Sales (8,400 units) $764,400 Variable expenses 445,200
Escareno Corporation has provided its contribution format income statement for June. The company produces and sells a single product.
Sales (8,400 units) $764,400
Variable expenses  445,200
Contribution margin 319,200
Fixed expenses  250,900
Net operating income $ 68,300
If the company sells 8,200 units, its total contribution margin should be closest to:
A) $301,000
B) $311,600
C) $319,200
D) $66,674 B

6. Ans:  B
Solution: Current contribution margin ÷ Current sales in units = Contribution margin per unit $319,200 ÷ 8,400 = $38 contribution margin per unit If 8,200 units are sold, the total contribution margin will be 8,200 × $38, or $311,600.

7. The Bronco Birdfeed Company reported the following information:
Sales (400 cases) $100,000
Variable expenses ,000
Contribution margin 40,000
Fixed expenses ,000
Net operating income $5,000
How much will the sale of one additional case add to Bronco's net operating income?
A) $250.00
B) $100.00
C) $150.00
D) $12.50 B

8. Ans:  B
Solution: Current contribution margin ÷ Current sales in cases = Contribution margin per case $40,000 ÷ 400 = $100 contribution margin per case If one additional case is sold, net operating income will increase by $100.

9. The margin of safety in the Flaherty Company is $24,000
The margin of safety in the Flaherty Company is $24,000. If the company's sales are $120,000 and its variable expenses are $80,000, its fixed expenses must be:
A) $8,000
B) $32,000
C) $24,000
D) $16,000 B

10. Ans:  B
Solution: Current sales - Breakeven sales = Margin of safety Substituting the given information into the above equation, we will have: $120,000 - Breakeven sales = $24,000 Breakeven sales = $96,000 Sales - Variable expenses = Contribution margin $120,000 - $80,000 = $40,000 Contribution margin ratio = Contribution margin ÷ Sales Contribution margin ratio = $ 40,000 ÷ $120,000 Contribution margin ratio = Breakeven sales = Fixed costs ÷ Contribution margin ratio $96,000 = Fixed costs ÷ Fixed costs = $32,000

11. A) The company's break-even point is $12,000 per month.
Dodero Company produces a single product which sells for $100 per unit. Fixed expenses total $12,000 per month, and variable expenses are $60 per unit. The company's sales average 500 units per month. Which of the following statements is correct?
A) The company's break-even point is $12,000 per month.
B) The fixed expenses remain constant at $24 per unit for any activity level within the relevant range.
C) The company's contribution margin ratio is 40%.
Responses A, B, and C are all correct. C

12. Ans: C Solution: Answer A is not correct because:
Sales = Variable expenses + Fixed expenses + Profit
$100Q = $60Q + $12,000 + $0
$40Q = $12,000
Q = $12,000 ÷ $40 per unit = 300 units
300 units × $100 selling price per unit = $30,000 breakeven sales in dollars
Answer B is not correct because fixed costs change as activity level changes
Answer C is correct because:
Contribution margin per unit = Selling price per unit - Variable expenses per unit
= $100 - $60 = $40
Contribution margin ratio = Contribution margin per unit ÷ Selling price per unit
Contribution margin ratio = $40 ÷ $100
Contribution margin ratio = 40%

13. Holt Company's variable expenses are 70% of sales
Holt Company's variable expenses are 70% of sales. At a $300,000 sales level, the degree of operating leverage is 10. If sales increase by $60,000, the degree of operating leverage will be:
A) 12
B) 10
C) 6
D) 4 D

14. Ans:  D
Solution: Sales $300,000 Variable expenses ($300,000 × 70%) 210,000 Contribution margin 90,000 Fixed expenses ? Net operating income $ ? Current degree of operating leverage = Current contribution margin ÷ Current net operating income 10 = $90,000 ÷ Current net operating income Current net operating income = $90,000 ÷ 10 = $9,000 Contribution margin = Fixed expenses - Net operating income $90,000 = Fixed expenses - $9,000 Fixed expenses = $90,000 - $9,000 = $81,000 Sales ($300,000 + $60,000) $360,000 Variable expenses ($360,000 × 70%) 252,000 Contribution margin 108,000 Fixed expenses 81,000 Net operating income $ 27,000 Degree of operating leverage = Contribution margin ÷ Net operating income = $108,000/$27,000 = 4.0

15. Gayne Corporation's contribution margin ratio is 12% and its fixed monthly expenses are $84,000. If the company's sales for a month are $738,000, what is the best estimate of the company's net operating income? Assume that the fixed monthly expenses do not change.
A) $565,440
B) $654,000
C) $88,560
D) $4,560 D

16. Ans:  D
Solution: Sales $738,000 Variable expenses ($738,000 × 88%) 649,440 Contribution margin ($738,000 × 12%) 88,560 Fixed expenses 84,000 Net operating income $ 4,560

17. Wilson Company prepared the following preliminary budget assuming no advertising expenditures:
Selling price $10 per unit
Unit sales ,000
Variable expenses $600,000
Fixed expenses $300,000
Based on a market study, the company estimated that it could increase the unit selling price by 15% and increase the unit sales volume by 10% if $100,000 were spent on advertising. Assuming that these changes are incorporated in its budget, what should be the budgeted net operating income?
A) $175,000
B) $190,000
C) $205,000
D) $365,000 C

18. Ans: C Solution: Sales (110,000 units × $11.50) $1,265,000
Variable expenses (110,000 units × $6*) 660,00
Contribution margin ,000
Fixed expenses ($300,000 + $100,000) ,000
Net operating income $ 205,000
* Current variable expenses ÷ Current sales in units = Variable expense per unit
$600,000 ÷ 100,000 = $6 variable expense per unit

19. Data concerning Kardas Corporation's single product appear below:
Per Unit Percent of Sales
Selling price $ %
Variable expenses      20%
Contribution margin $  80%
The company is currently selling 8,000 units per month. Fixed expenses are $719,000 per month. The marketing manager believes that a $20,000 increase in the monthly advertising budget would result in a 180 unit increase in monthly sales. What should be the overall effect on the company's monthly net operating income of this change?
A) decrease of $160
B) increase of $20,160
C) decrease of $20,000
D) increase of $160 D

20. Ans:  D
Solution: 8,000 units 8,180 units Sales (8,000 units, 8,180 units × $140) $1,120,000 $1,145,200 Variable expenses : ($1,120,000, $1,145,200 × 20%) 224, ,040 Contribution margin = 896, ,160 Fixed expenses = 719, ,000 Net operating income = $ 177,000 $ 177,160 Increase in net operating income: $177,160 - $177,000 = $160