250 Chapter 6

4. Confirm the calculations you made in part (3) above by increasing the unit sales in your worksheet by
15%. What is the new net operating income and by what percentage did it increase?
5. Thad Morgan, a motorcycle enthusiast, has been exploring the possibility of relaunching the Western
Hombre brand of cycle that was popular in the 1930s. The retro-look cycle would be sold for $10,000
and at that price, Thad estimates that he could sell 600 units each year. The variable cost to produce
and sell the cycles would be $7,500 per unit. The annual fixed cost would be $1,200,000.
a. Using your worksheet, what would be the unit sales to break even, the margin of safety in dollars,
and the degree of operating leverage?
b. Thad is worried about the selling price. Rumors are circulating that other retro brands of cycles
may be revived. If so, the selling price for the Western Hombre would have to be reduced to
$9,000 to compete effectively. In that event, Thad also would reduce fixed expenses by $300,000
by reducing advertising expenses, but he still hopes to sell 600 units per year. Do you think this
is a good plan? Explain. Also, explain the degree of operating leverage that appears on your
worksheet.

THE FOUNDATIONAL 15 

LO6–1, LO6–3, LO6–4, Oslo Company prepared the following contribution format income statement based on a sales volume of
LO6–5, LO6–6, LO6–7, 1,000 units (the relevant range of production is 500 units to 1,500 units):
LO6–8
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $20,000
Variable expenses . . . . . . . . . . . . . . . . . . . . . . . . . . .   12,000
Contribution margin . . . . . . . . . . . . . . . . . . . . . . . . . 8,000
Fixed expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . .     6,000
Net operating income . . . . . . . . . . . . . . . . . . . . . . . . $   2,000

Required:
(Answer each question independently and always refer to the original data unless instructed otherwise.)
1. What is the contribution margin per unit?
2. What is the contribution margin ratio?
3. What is the variable expense ratio?
4. If sales increase to 1,001 units, what would be the increase in net operating income?
5. If sales decline to 900 units, what would be the net operating income?
6. If the selling price increases by $2 per unit and the sales volume decreases by 100 units, what would
be the net operating income?
7. If the variable cost per unit increases by $1, spending on advertising increases by $1,500, and unit
sales increase by 250 units, what would be the net operating income?
8. What is the break-even point in unit sales?
9. What is the break-even point in dollar sales?
10. How many units must be sold to achieve a target profit of $5,000?
11. What is the margin of safety in dollars? What is the margin of safety percentage?
12. What is the degree of operating leverage?
13. Using the degree of operating leverage, what is the estimated percent increase in net operating income
of a 5% increase in sales?
14. Assume that the amounts of the company’s total variable expenses and total fixed expenses were
reversed. In other words, assume that the total variable expenses are $6,000 and the total fixed
expenses are $12,000. Under this scenario and assuming that total sales remain the same, what is the
degree of operating leverage?
15. Using the degree of operating leverage that you computed in the previous question, what is the
estimated percent increase in net operating income of a 5% increase in sales?

EXERCISES
EXERCISE 6–1  The Effect of Changes in Activity on Net Operating Income LO6–1
Whirly Corporation’s contribution format income statement for the most recent month is shown below:
 Cost-Volume-Profit Relationships 251

Total Per Unit

Sales (10,000 units) . . . . . . . . . . . . . . . . . $350,000 $35.00

Variable expenses . . . . . . . . . . . . . . . . . .     200,000    20.00
Contribution margin . . . . . . . . . . . . . . . . 150,000 $15.00
Fixed expenses . . . . . . . . . . . . . . . . . . . .    135,000
Net operating income . . . . . . . . . . . . . . . $ 15,000

Required:
(Consider each case independently):
1. What would be the revised net operating income per month if the sales volume increases by 100 units?
2. What would be the revised net operating income per month if the sales volume decreases by 100 units?
3. What would be the revised net operating income per month if the sales volume is 9,000 units?
EXERCISE 6–2  Prepare a Cost-Volume-Profit (CVP) Graph LO6–2
Karlik Enterprises distributes a single product whose selling price is $24 per unit and whose variable
expense is $18 per unit. The company’s monthly fixed expense is $24,000.

Required:
1 . Prepare a cost-volume-profit graph for the company up to a sales level of 8,000 units.
2. Estimate the company’s break-even point in unit sales using your cost-volume-profit graph.
EXERCISE 6–3  Prepare a Profit Graph LO6–2
Jaffre Enterprises distributes a single product whose selling price is $16 per unit and whose variable
expense is $11 per unit. The company’s fixed expense is $16,000 per month.

Required:
1 . Prepare a profit graph for the company up to a sales level of 4,000 units.
2. Estimate the company’s break-even point in unit sales using your profit graph.
EXERCISE 6–4  Computing and Using the CM Ratio LO6–3
Last month when Holiday Creations, Inc., sold 50,000 units, total sales were $200,000, total variable
expenses were $120,000, and fixed expenses were $65,000.

Required:
1 . What is the company’s contribution margin (CM) ratio?
2. What is the estimated change in the company’s net operating income if it can increase total sales by
$1,000?
EXERCISE 6–5  Changes in Variable Costs, Fixed Costs, Selling Price, and Volume LO6–4
Data for Hermann Corporation are shown below:

Per Unit Percent of Sales

Selling price . . . . . . . . . . . . . . . . $90 100%

Variable expenses . . . . . . . . . . .   63   70
Contribution margin . . . . . . . . . $27  30%

Fixed expenses are $30,000 per month and the company is selling 2,000 units per month.

Required:
1. How much will net operating income increase (decrease) per month if the monthly advertising budget
increases by $5,000 and monthly sales increase by $9,000?
2. Refer to the original data. How much will net operating income increase (decrease) per month if
the company uses higher-quality components that increase the variable expense by $2 per unit and
increase unit sales by 10%.
EXERCISE 6–6  Break-Even Analysis LO6–5
Mauro Products distributes a single product, a woven basket whose selling price is $15 per unit and whose
variable expense is $12 per unit. The company’s monthly fixed expense is $4,200.
252 Chapter 6

Required:
1 . Calculate the company’s break-even point in unit sales.
2. Calculate the company’s break-even point in dollar sales.
3. If the company’s fixed expenses increase by $600, what would become the new break-even point in
unit sales? In dollar sales?
EXERCISE 6–7  Target Profit Analysis LO6–6
Lin Corporation has a single product whose selling price is $120 per unit and whose variable expense is
$80 per unit. The company’s monthly fixed expense is $50,000.

Required:
1 . Calculate the unit sales needed to attain a target profit of $10,000.
2. Calculate the dollar sales needed to attain a target profit of $15,000.
EXERCISE 6–8  Compute the Margin of Safety LO6–7
Molander Corporation is a distributor of a sun umbrella used at resort hotels. Data concerning the next
month’s budget appear below:

Selling price per unit . . . . . . . . . . . $30

Variable expense per unit . . . . . . $20
Fixed expense per month . . . . . . $7,500
Unit sales per month . . . . . . . . . . . 1,000

Required:
1 . What is the company’s margin of safety?
2. What is the company’s margin of safety as a percentage of its sales?
EXERCISE 6–9  Compute and Use the Degree of Operating Leverage LO6–8
Engberg Company installs lawn sod in home yards. The company’s most recent monthly contribution for-
mat income statement follows:

Amount Percent of Sales

Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . $80,000 100%

Variable expenses . . . . . . . . . . . . . . . . .     32,000    40%
Contribution margin . . . . . . . . . . . . . . .    48,000    60%
Fixed expenses . . . . . . . . . . . . . . . . . . .     38,000
Net operating income . . . . . . . . . . . . . . $10,000

Required:
1 . What is the company’s degree of operating leverage?
2. Using the degree of operating leverage, estimate the impact on net operating income of a 5% increase
in sales.
3. Verify your estimate from part (2) above by constructing a new contribution format income statement
for the company assuming a 5% increase in sales.
EXERCISE 6–10  Multiproduct Break-Even Analysis LO6–9
Lucido Products markets two computer games: Claimjumper and Makeover. A contribution format income
statement for a recent month for the two games appears below:

Claimjumper Makeover Total

Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . $30,000 $70,000 $100,000

Variable expenses . . . . . . . . . . . . . . . . .    20,000    50,000      70,000
Contribution margin . . . . . . . . . . . . . . . $10,000 $20,000  30,000
Fixed expenses . . . . . . . . . . . . . . . . . . .      24,000
Net operating income . . . . . . . . . . . . . . $     6,000

Required:
1 . What is the overall contribution margin (CM) ratio for the company?
2. What is the company’s overall break-even point in dollar sales?
 Cost-Volume-Profit Relationships 255

Required:
1 . What is the break-even point in unit sales and in dollar sales?
2. If the variable expenses per stove increase as a percentage of the selling price, will it result in a higher
or a lower break-even point? Why? (Assume that the fixed expenses remain unchanged.)
3. At present, the company is selling 8,000 stoves per month. The sales manager is convinced that a 10%
reduction in the selling price would result in a 25% increase in monthly sales of stoves. Prepare two
contribution format income statements, one under present operating conditions, and one as operations
would appear after the proposed changes. Show both total and per unit data on your statements.
4. Refer to the data in (3) above. How many stoves would have to be sold at the new selling price to attain
a target profit of $35,000 per month?

EXERCISE 6–18  Break-Even and Target Profit Analysis; Margin of Safety; CM Ratio LO6–1, LO6–3,
LO6–5, LO6–6, LO6–7
Menlo Company distributes a single product. The company’s sales and expenses for last month follow:

Total Per Unit

Sales . . . . . . . . . . . . . . . . . . . . . . . . . . $450,000 $30

Variable expenses . . . . . . . . . . . . . . .   180,000   12
Contribution margin . . . . . . . . . . . . .  270,000 $18
Fixed expenses . . . . . . . . . . . . . . . . .   216,000
Net operating income . . . . . . . . . . . . $  54,000

Required:
1 . What is the monthly break-even point in unit sales and in dollar sales?
2. Without resorting to computations, what is the total contribution margin at the break-even point?
3. How many units would have to be sold each month to attain a target profit of $90,000? Verify your
answer by preparing a contribution format income statement at the target sales level.
4. Refer to the original data. Compute the company’s margin of safety in both dollar and percentage
terms.
5. What is the company’s CM ratio? If sales increase by $50,000 per month and there is no change in
fixed expenses, by how much would you expect monthly net operating income to increase?

 PROBLEMS
PROBLEM 6–19  Break-Even Analysis; Pricing LO6–1, LO6–4, LO6–5
Minden Company introduced a new product last year for which it is trying to find an optimal selling price.
Marketing studies suggest that the company can increase sales by 5,000 units for each $2 reduction in
the selling price. The company’s present selling price is $70 per unit, and variable expenses are $40 per
unit. Fixed expenses are $540,000 per year. The present annual sales volume (at the $70 selling price) is
15,000 units.

Required:
1 . What is the present yearly net operating income or loss?
2. What is the present break-even point in unit sales and in dollar sales?
3. Assuming that the marketing studies are correct, what is the maximum annual profit that the company
can earn? At how many units and at what selling price per unit would the company generate this
profit?
4. What would be the break-even point in unit sales and in dollar sales using the selling price you
determined in (3) above (e.g., the selling price at the level of maximum profits)? Why is this break-
even point different from the break-even point you computed in (2) above?

PROBLEM 6–20  CVP Applications: Break-Even Analysis; Cost Structure; Target Sales LO6–1,
LO6–3, LO6–4, LO6–5, LO6–6, LO6–8
Northwood Company manufactures basketballs. The company has a ball that sells for $25. At present, the
ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable expenses are
high, totaling $15 per ball, of which 60% is direct labor cost.
256 Chapter 6

Last year, the company sold 30,000 of these balls, with the following results:

Sales (30,000 balls) . . . . . . . . . . . . . . . . . . . . . . . $750,000

Variable expenses . . . . . . . . . . . . . . . . . . . . . . . .    450,000
Contribution margin . . . . . . . . . . . . . . . . . . . . . . 300,000
Fixed expenses . . . . . . . . . . . . . . . . . . . . . . . . . .   210,000
Net operating income . . . . . . . . . . . . . . . . . . . . . $    90,000

Required:
1. Compute (a) last year’s CM ratio and the break-even point in balls, and (b) the degree of operating
leverage at last year’s sales level.
2. Due to an increase in labor rates, the company estimates that next year’s variable expenses will
increase by $3 per ball. If this change takes place and the selling price per ball remains constant at
$25, what will be next year’s CM ratio and the break-even point in balls?
3. Refer to the data in (2) above. If the expected change in variable expenses takes place, how many balls
will have to be sold next year to earn the same net operating income, $90,000, as last year?
4. Refer again to the data in (2) above. The president feels that the company must raise the selling
price of its basketballs. If Northwood Company wants to maintain the same CM ratio as last year
(as computed in requirement 1a), what selling price per ball must it charge next year to cover the
increased labor costs?
5. Refer to the original data. The company is discussing the construction of a new, automated

manufacturing plant. The new plant would slash variable expenses per ball by 40%, but it would cause
fixed expenses per year to double. If the new plant is built, what would be the company’s new CM
ratio and new break-even point in balls?
6. Refer to the data in (5) above.
a. If the new plant is built, how many balls will have to be sold next year to earn the same net
operating income, $90,000, as last year?
b. Assume the new plant is built and that next year the company manufactures and sells 30,000 balls
(the same number as sold last year). Prepare a contribution format income statement and compute
the degree of operating leverage.
c. If you were a member of top management, would you have been in favor of constructing the new
plant? Explain.

PROBLEM 6–21  Sales Mix; Multiproduct Break-Even Analysis LO6–9

Gold Star Rice, Ltd., of Thailand exports Thai rice throughout Asia. The company grows three varieties
of rice—White, Fragrant, and Loonzain. Budgeted sales by product and in total for the coming month are
shown below:

Product

White Fragrant Loonzain Total

Percentage of total sales . . . . . . . . . . . . . 20% 52% 28% 100%

Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $150,000 100% $390,000 100% $210,000 100% $750,000 100%
Variable expenses . . . . . . . . . . . . . . . . . . .   108,000  72%   78,000  20%   84,000  40%   270,000  36%
Contribution margin . . . . . . . . . . . . . . . . . $ 42,000  28% $312,000  80% $126,000  60%   480,000  64%
Fixed expenses . . . . . . . . . . . . . . . . . . . . .   449,280
Net operating income . . . . . . . . . . . . . . . . $  30,720

Dollar sales to Fixed expenses ________

$449,280
​​​ = ​ _____________
 ​​      ​ = ​  = $702,000​​
 ​ 
 
break-even CM ratio 0.64

As shown by these data, net operating income is budgeted at $30,720 for the month and the estimated
break-even sales is $702,000.