ECG company sells lightweight tables. One table is sold for $45. Variable and fixed cost data is given below:

Variable cost $18 per unit
Fixed cost $540,000 per year

Required:

  1. Calculate contribution margin ratio (CM ratio) of the product.
  2. Calculate break-even point in dollars using CM ratio.
  3. Calculate the increase in net operating income if sales increase by $135,000. Use CM ratio for your answer.
  4. During the last year, ECG company sold 24,000 lightweight tables.
    (a). Compute the degree of operating leverage at the last year’s level of sales.
    (b). If ECG company manages to increase the sales by 15% next year, how much should net operating income  increase?

Solution:

(1) Calculation of CM ratio:

Contribution margin / Sales revenue

$27* / $45

0.60 or 60%

*$45 – $18 = $27

 (2) Calculation of break-even point:

Break-even point in sales = Fixed cost / CM ratio

$540,000 / 0.60

$900,000

(3) Increase in net operating income:

$135,000 × 0.6

$81,000

(4) Degree of operating leverage:

(a).

Degree of operating leverage = Contribution margin / Net operating income

= $648,000* / $108,000**

= 6

*[(24,000 × $45) – (24,000 × $18)]

= $1,080,000 – 432,000

= $648,000

**$648,000 – 540,000

= 108,000

(b).

The degree of operating leverage is 6. If sales increase by 15% the net operating income will increase by 90% (15% × 6).

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