Companies often use leverage to augment profits. Based on what you learned this week, please explain the following in detail:
With regards to Operating Leverage, please explain why a company with HIGH Operating Leverage faces greater financial risk in a declining sales period compared to a company with LOW Operating Leverage. (HINT: The key here is the relation between fixed costs and variable costs.)
What does a business's Contribution Margin represent? What does the Contribution Margin have to do with Operating Leverage?
Companies often use leverage to augment profits. Based on what you learned this week, please explain the following in detail:
With regards to Operating Leverage, please explain why a company with HIGH Operating Leverage faces greater financial risk in a declining sales period compared to a company with LOW Operating Leverage. (HINT: The key here is the relation between fixed costs and variable costs.)
What does a business's Contribution Margin represent? What does the Contribution Margin have to do with Operating Leverage?
Related questions
Need help with my case study for my managerial accouting class,any help will be greatly appreciated.
Part 1 15 points
Cingle Company LLC produces gadgets at one manufacturingfactory. Corporate headquarters are located at the same site.Historical cost information shows the average costs at thefollowing production levels .
Production in units | 3,000 | 3,750 | 4,500 |
Cost of goods manufactured | |||
Direct Materials | $ 198,000 | $ 247,500 | $297,000 |
Direct Labor | 126,000 | 157,500 | 189,000 |
Overhead | |||
Building depreciation-factory | 5,000 | 5,000 | 5,000 |
Equipmentlease | 4,500 | 4,500 | 4,500 |
Factorysupplies | 1,600 | 1,930 | 2,260 |
Indirect Labor | 5,500 | 5,500 | 5,500 |
Quality InspectionCosts | 13,360 | 14,200 | 15,040 |
Selling and Administrative Expenses | |||
Shipping | 45,500 | 51,875 | 58,250 |
Advertisingexpense | 50,000 | 50,000 | 50,000 |
Salaries andcommissions | 137,000 | 155,000 | 173,000 |
Insuranceexpense | 10,000 | 10,000 | 10,000 |
Total | $ 596,460 | $ 703,005 | $ 809,550 |
A. Identify each ofthe companyâs costs as being variable, fixed or mixed with respectto the number of units produced. Explain why you chose that costbehavior. [Hint: What happens to total cost if the cost behavior isfixed, is variable, is mixed? What happens to cost / unit if costbehavior is fixed, is variable, is mixed?] Show all computationsneeded to determine cost behavior.
NOTE: If the cost is mixed, please use thechart in part B to detail your explanation.
Use the chart below:
Cost | Fixed | Variable | Mixed | Explanation |
Direct Materials | X | The total cost increases but cost/unit ($66) remainsconstant. | ||
Direct Labor | ||||
Building depreciation-factory | ||||
Equipment lease | ||||
Factory supplies | ||||
Indirect Labor | ||||
Quality Inspection Costs | ||||
Shipping | ||||
Advertising expense | ||||
Salaries and commissions | ||||
Insurance expense |
B. Using the high-lowmethod, separate each mixed cost into variable and fixed elements.State the cost formula for each mixed cost. Show all your work andcomputations.
Use the chart below:
Mixed Cost (Name) | Cost Formula (Y = a + bx form) | Supporting Computations |
C. Determine the expectedtotal costs (identify each cost separately) at a production levelof 5,000 widgets. Show computations. You should arrive at a totalcost figure.
Use the chart below:
Cost | Supporting Computations | |
Direct Materials | ||
Direct Labor | ||
Building dep-factory portion | ||
Equipment lease | ||
Factory supplies | ||
Indirect Labor | ||
Quality Inspection Costs | ||
Shipping | ||
Advertising expense | ||
Salaries and commissions | ||
Insurance expense | ||
TOTAL COST |
D. State the costequation for the total costs of the entire company in the form Y =a + bx. Using alternative one or alternative two below, show howyou determined the cost equation. (Note: you should have oneequation such that someone could determine expected total cost forany activity level within the relevant range.)
Company â Wide Cost equation:
Use the chart below (Alternative one) which shows the fixed costportion and the variable rate for each cost itemor use the high- low method (Alternative two) fordetermining the cost equation. You need to choose only onealternative.
Alternative one: (use the information and chartfrom part A and the information from part B. Input the $ amounts inappropriate columns and total the columns of the chart. Using thechart information, state the cost equation in the Y = a + bxform.)
Fixed Cost | Variable Rate ($/unit) | |
Direct Materials | ||
Direct Labor | ||
Building dep-factory portion | ||
Equipment lease | ||
Factory supplies | ||
Indirect Labor | ||
Quality Inspection Costs | ||
Shipping | ||
Advertising expense | ||
Salaries and commissions | ||
Insurance expense | ||
TOTAL COST |
Alternativetwo: High-low method and supporting, labeledcomputations.
Part Two 20 points
Goggle Company manufactures a special virtual reality gogglethat can be used underwater. The companyâs contribution formatincome statement for last year is below:
Total | Per Unit | % of Sales | |
Sales (10,000 units) | $750,000 | $75 | 100% |
Variable Expenses | 450,000 | 45 | ? |
Contribution Margin | 300,000 | $30 | ? |
Fixed Expenses | 170,000 | ||
Net Operating Income | $130,000 |
Goggle Company is ready to take off and expand its market share.Management has asked for several items to be analyzed in order tomake good decisions.
Calculate the companyâs contribution margin ratio and thevariable expense ratio.
Compute the companyâs break-even point in both units and insales dollars. You may use either the equation method or theformula method.
Management is predicting a 20% increase in sales next year,staying within the relevant range for the company. How much willthe companyâs net operating income increase?
Refer to the original data. Assume that management would like toearn a profit of at least $55,000. How many units will have to besold to meet this target profit?
Refer to the original data. Compute the company's margin ofsafety in both dollar and percentage form.
Compute the company's degree of operating leverage at thepresent level of sales.
Assume that through a more intense effort by the sales staff,the company's sales increase by 8% next year. By what percentagewould you expect net operating income to increase? Use the degreeof operating leverage to obtain your answer.
Verify your answer to (b) by preparing a new contribution formatincome statement showing an 8% increase in sales.
In an effort to increase sales and profits, management isconsidering the use of a higher quality virtual reality system thanthe current system. The new system would increase variable costs by$15 per unit, but management could eliminate one quality inspectorwho is paid a salary of $30,000 per year. Management believes theycan increase the selling price by $30 per unit.
Assuming that changes are made as described above, prepare aprojected contribution format income statement for next year. Showdata on a total, per unit, and percentage basis.
Compute the company's new break-even point in both units anddollars of sales. Use the formula method.
Would you recommend that the changes be made? Why or whynot?
