POST-VOLUME PROFIT ANALYSIS carpet sale at the carpeg 3-25 operating leverage. C

Question

POST-VOLUME PROFIT ANALYSIS carpet sale at the carpeg 3-25 operating leverage. Carmel Rugs is holding a 2-week company units f store. Carmel Rugs plans to sell carpets for each. The space any ocal distributor for each, the privilege of the use of has offered Carmel Rugs two payment alternatives for Option 1: A fixed payment of s17,400 for the sale period period Option 2: 20% of total revenues earned during the sale Assume Carmel Rugs will incur no other costs option 2 under eithe option? 1. Calculate the breakeven point in units for (a) option 1 and (b) income 2. At what level of revenues will Carmel Rugs earn the same operating a. For what range of unit sales will Carmel Rugs prefer option 2? optio For what range of unit sales will Carmel Rugs prefer option rental 3. Calculate the degree of operating leverage at sales of 87 units for the two 4. Briefly explain and interpret your answer to requirement 3 Inc., is considering three pos 3-26 CVP analysis, international cost structure differences. P Decor, All area ru countries for the sole manufacturing site of its newest area rug: Italy, Spain, and Singapore. markup to be sold to retail outlets in the United States for $200 per unit. These retail outlets add their own selling to final customers. Fixed costs and variable cost per unit (area rug) differ in the three countries Variable Variable Marketing Manufacturing Annual Sales Price Distribution Cost per Fixed to Retail ner Area

Explanation / Answer

Part 1)

The breakeven point in units can be derived with the use of following equation:

(Selling Price - Variable Cost)*Breakeven Quantity = Fixed Cost

or Breakeven Quantity = Fixed Cost/(Selling Price - Variable Cost)

_________

Option 1)

Here, Fixed Cost = $17,400, Selling Price = $1,000 and Variable Cost = $400

Breakeven Quantity = 17,400/(1,000-400) = 29 carpets

_________

Option 2)

Here, Fixed Cost = 0, Selling Price = $1,000 and Variable Cost = $400 + $1,000*20% (a form of commission) = $600

Breakeven Quantity = 0/(1,000 - 600) = 0

_________

Part 2)

The equation for operating income under Option 1 and Option 2 are given below:

Operating Income (Option 1) = (1,000 - 400)*Q - 17,400 or 600Q - 17,400

Operating Income (Option 2) = (1,000 - 400 - 200)*Q or 400Q

To achieve the same level of operating income, we need to solve for Q by equating the 2 equations as follows:

600Q - 17,400 = 400Q

Q = 17,400/(200) = 87 carpets

For 87 carpets, the net operating income under Option 1 is $34,800 (600*87 - 17,400) and under Option 2 is $34,800 (400*87).

Therefore, at a level of $87,000 (1,000*87) revenues, the operating income will be same under both the options.

__________

2a) and 2b)

We need to calculate the value of operating income if the quantity sold exceeds 87 carpets (that is, 88 units) and if it is less than 87 carpets (that is, 86 units) under both the options.

If Quantity Sold is 88 carpets:

Operating Income (Option 1) = 600*88 - 17,400 = $35,400

Operating Income (Option 2) = 400*88 = $35,200

In this case Carmel Rugs will prefer Option 1

__________

If Quantity Sold is 86 carpets:

Operating Income (Option 1) = 600*86 - 17,400 = $34,200

Operating Income (Option 2) = 400*86 = $34,400

In this case Carmel Rugs will prefer Option 2

Therefore, it can be concluded that for less than 87 units (1 to 86), Carmel Rugs will prefer Option 2 and for more than 87 units (>87), Carmel Rugs will prefer Option 1.

_________

Part 3)

The degree of operating leverage can be calculated with the use of following formula:

Degree of Operating Leverage = Contribution/Operating Income

_________

Degree of Operating Leverage (Option 1) = ((1,000 - 400)*87)/34,800 = 1.50

Degree of Operating Leverage (Option 2) = ((1,000 - 400 - 20%*1000)*87)/34,800 = 1

_________

Part D)

The degree of operating leverage calculated in Part C indicates that at a sales level of 87 units, any change in contribution margin or sales will change operating income by 1.5 times. Under option 2, on the other hand, the percentage change in operating income will be the same as the change in contribution margin or sales.

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