Arquitectos Interiores of Juarez, Mexico, is contemplating a major change in its

Question

Arquitectos Interiores of Juarez, Mexico, is contemplating a major change in its cost structure. Currently, all of its drafting work is performed by skilled draftsmen. Alfonso Jiminez, Arquitectos’ owner, is considering replacing the draftsmen with a computerized drafting system. However, before making the change, Alfonso would like to know the consequences of the change, since the volume of business varies significantly from year to year. Shown below are CVP income statements for each alternative.

(a) Determine the degree of operating leverage for each alternative. (Round answers to 2 decimal place, e.g. 1.25.)

(b) Calculate the increase in Net income for each alternative if sales increased by $110,000.

Which alternative would produce the higher net income? ______________?

(c) Calculate the margin of safety ratio. (Round ratios to 2 decimal place, e.g. 0.25.)

Using the margin of safety ratio, determine which alternative could sustain the greater decline in sales before operating at a loss.

Manual System or Computerized System?

(Leave Blank) Manual System Computerized System Sales $1,760,000 $1,760,000 Variable costs 1,408,000 704,000 Contribution margin 352,000 1,056,000 Fixed costs 117,333 821,333 Net income $234,667 $234,667

Explanation / Answer

a) Operating Leverage = Contribution/Net Inccome

Operating Leverage for Manual System = 352,000/234,667

= 1.50

Operating Leverage for Computersied system = 1,056,000/234,667

= 4.50%

..

b) Increase in sales (%) = 110,000/17,60,000 * 100

= 6.25%

..

Increase in net income under manual system if sales increase by 6.25% = 110,000*1.0625*1.5

= $175,312.50

..

Increase in net income under computerised system if sales increase by 6.25% = 110,000*1.0625*4.5

= $525,937.50

..

..

c)Breakeven sales for manual system = 117,333/0.2

= 586,665

MOS for manual = (1760,000-586,665)/1760,000 * 100

= 66.67%

..

BEP for computereised system = 821,333/0.6

= 1368,888

MOS for Computerised system = (1760,000 - 1368,888)/1760,000

= 22.22%

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