Casas Modernas of Juarez, Mexico, is contemplating a major change in its cost st
ID: 2548016 • Letter: C
Question
Casas Modernas of Juarez, Mexico, is contemplating a major change in its cost structure. Currently, all of its drafting work is performed by skilled draftsmen. Rafael Jiminez, Casas’ owner, is considering replacing the draftsmen with a computerized drafting system. However, before making the change, Rafael 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.
Manual
System
Computerized
System
(b)
Calculate the increase in Net income for each alternative if sales increased by $128,000. The degrees of operating leverage for manual system is 1.35 and the degree of operating leverage for computarized system is 4.05
Casas Modernas of Juarez, Mexico, is contemplating a major change in its cost structure. Currently, all of its drafting work is performed by skilled draftsmen. Rafael Jiminez, Casas’ owner, is considering replacing the draftsmen with a computerized drafting system. However, before making the change, Rafael 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.
Manual
System
Computerized
System
Explanation / Answer
Casas Modernas
Determination of increase in net income if sales for each alternative increased by $128,000:
Degree of operating leverage is an effective tool to determine the change in net income with change in sales level.
Degree of operating leverage = contribution margin/net income
Manual System
Computerized System
degree of operating leverage
Contribution margin
$332,000
$996,000
Net Income
$245,926
$245,926
degree of operating leverage
332,000/245,926
996,000/245,926
1.35
4.05
change in net income -
increase in sales
$128,000
$128,000
% increase in sales 128,000/1,660,000
128,000/1,660,000
7.7%
7.7%
Change in net income = percent increase in sales x degree of operating leverage
7.7% x 1.35
7.7% x 4.05
10.41%
31.23%
Hence, when sales increase by $128,000, net income increases by 10.41% for manual system and 31.23% for computerized system.
Net income –
Manual System - $1,660,000 x 10.41% = $172,806
Computerized System = $1,660,000 x 31.23% = $518,418
Alternative 2, Computerized System provides higher net income.
Manual System
Computerized System
degree of operating leverage
Contribution margin
$332,000
$996,000
Net Income
$245,926
$245,926
degree of operating leverage
332,000/245,926
996,000/245,926
1.35
4.05
change in net income -
increase in sales
$128,000
$128,000
% increase in sales 128,000/1,660,000
128,000/1,660,000
7.7%
7.7%
Change in net income = percent increase in sales x degree of operating leverage
7.7% x 1.35
7.7% x 4.05
10.41%
31.23%
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