EXERCISE @ ewinsky Company manufactures and sells one product at a price of $30

Question

EXERCISE @ ewinsky Company manufactures and sells one product at a price of $30 per unit. Its variable cost is $12 per unit, and its fixed costs for the year amount to $360,000. Required a. Calculate the breakeven sales in dollacs and units. b. If the company's expected sales are 30,000 units, what profit before laves is earned a that level of activity? c. At the level of activity in (b) above, what is the company's Margin of Safety? At the level of activily in (c) above, what is the operating leverage of the company? Why is the concept of operating leverage important and what is it used for? Assume that the Hilary Corp, a rival of Lewinsky company has an operating leverage of 10. Which company is more risky? Assuming a tax rate of 30% how many units must the company se" to make L profit after tax of $350,000? e. f. For the next year, Jack Clinton, the Marketing Manager, is contemplating an increase in selling price by 20%. Market research indicates that this would cause a reduction in sales volume of 30 percent from the 30,000 units expected this year. The Marketing manager staies that, despiie this, the strategy is beneficial to the company relative to the existing strategy (refer b above). As the accounlanl, would you recommend the price change? g What would the new breakeven sales in units and dollars be if the change in (f) above were implemented? Would you agree with Climton that the strategy is beneficial to the company? h. As an alternative to the strategy in (0) above, the company is considering improving the quality of the product, which would raise the variable cost per unit to S15. In addition, advertising of the product would be required at a cost of $20,000. This amount is in addition to the fixed costs of $360,000. The selling price would be increased to $40 per unit. At this price, it is expected that sales volume would be reduced by 20 percent What would the effect on the company's income be of the proposed changes?

Explanation / Answer

Solution a:

Selling price per unit = $30

Variable cost per unit = $12

Contribution margin per unit = $30 - $12 = $18

Fixed cost = $360,000

Breakeven sales in units = Fixed cost / contribution per unit = $360,000 / $18 = 20000 units

Breakeven sales in dollar = 20000 * $30 = $600,000

Solution b:

Expected sales unit = 30000 units

Expected contribution margin = 30000 * $18 = $540,000

Expected Profit before taxes = Expected contribution - Fixed cost = $540,000 - $360,000 = $180,000

Solution c:

Margin of safety = Current sales - Breakeven sales = 30000 units - 20000 units = 10000 units

Margin of safety in percentage = (30000 - 20000) / 30000 = 33.33%

Solution d:

Operating leverage = Contribution margin / EBIT

= $540,000 / $180,000 = 3 times

Operating leverage is a measurement of the degree to which a comapny incurs a combination of fixed and variable costs. A comapny that makes sales with high gross profit and lower fixed costs and variable costs has lesser leverage. The higher the degree of operating leverage, the higher is risk of danger.

Operating leverage may be used for calculating a company’s breakeven point and substantially affecting profits by changing its pricing structure. Because frirm with higher operating leverage do not proportionately increase expenses as they increase sales, those firm may bring in more revenue than other companies.

In the given question Hilary Corp, a rival of Lewinsky company has a operating leverage of 10. Hence Hilary corp. is more risky then Lewinsky company.

Note: I have answered first 4 parts as per chegg policy. Kindly post separate question for answer of remaining parts.

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