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Case Study

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**The margin of safety can be calculated by:**

A) Sales − (Fixed expenses/Contribution margin ratio). B) Sales − (Fixed expenses/Variable expense per unit). C) Sales − (Fixed expenses + Variable expenses). D) Sales − Net operating income. A

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**Hopi Corporation expects the following operating results for next year:**

Sales $400,000 Margin of safety $100,000 Contribution margin ratio 75% Degree of operating leverage 4 What is Hopi expecting total fixed expenses to be next year? A) $75,000 B) $100,000 C) $200,000 D) $225,000 D

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**Ans: D Solution: Current sales - Breakeven sales = Margin of safety**

Substituting the given information into the above equation, we will have: $400,000 − Breakeven sales = $100,000 Breakeven sales = $300,000 Breakeven sales = Fixed expenses ÷ Contribution margin ratio $300,000 = Fixed expenses ÷ 0.75 Fixed expenses = $225,000

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**Sales (8,400 units) $764,400 Variable expenses 445,200**

Escareno Corporation has provided its contribution format income statement for June. The company produces and sells a single product. Sales (8,400 units) $764,400 Variable expenses 445,200 Contribution margin 319,200 Fixed expenses 250,900 Net operating income $ 68,300 If the company sells 8,200 units, its total contribution margin should be closest to: A) $301,000 B) $311,600 C) $319,200 D) $66,674 B

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Ans: B Solution: Current contribution margin ÷ Current sales in units = Contribution margin per unit $319,200 ÷ 8,400 = $38 contribution margin per unit If 8,200 units are sold, the total contribution margin will be 8,200 × $38, or $311,600.

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**The Bronco Birdfeed Company reported the following information:**

Sales (400 cases) $100,000 Variable expenses ,000 Contribution margin 40,000 Fixed expenses ,000 Net operating income $5,000 How much will the sale of one additional case add to Bronco's net operating income? A) $250.00 B) $100.00 C) $150.00 D) $12.50 B

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Ans: B Solution: Current contribution margin ÷ Current sales in cases = Contribution margin per case $40,000 ÷ 400 = $100 contribution margin per case If one additional case is sold, net operating income will increase by $100.

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**The margin of safety in the Flaherty Company is $24,000**

The margin of safety in the Flaherty Company is $24,000. If the company's sales are $120,000 and its variable expenses are $80,000, its fixed expenses must be: A) $8,000 B) $32,000 C) $24,000 D) $16,000 B

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Ans: B Solution: Current sales - Breakeven sales = Margin of safety Substituting the given information into the above equation, we will have: $120,000 - Breakeven sales = $24,000 Breakeven sales = $96,000 Sales - Variable expenses = Contribution margin $120,000 - $80,000 = $40,000 Contribution margin ratio = Contribution margin ÷ Sales Contribution margin ratio = $ 40,000 ÷ $120,000 Contribution margin ratio = Breakeven sales = Fixed costs ÷ Contribution margin ratio $96,000 = Fixed costs ÷ Fixed costs = $32,000

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**A) The company's break-even point is $12,000 per month. **

Dodero Company produces a single product which sells for $100 per unit. Fixed expenses total $12,000 per month, and variable expenses are $60 per unit. The company's sales average 500 units per month. Which of the following statements is correct? A) The company's break-even point is $12,000 per month. B) The fixed expenses remain constant at $24 per unit for any activity level within the relevant range. C) The company's contribution margin ratio is 40%. Responses A, B, and C are all correct. C

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**Ans: C Solution: Answer A is not correct because:**

Sales = Variable expenses + Fixed expenses + Profit $100Q = $60Q + $12,000 + $0 $40Q = $12,000 Q = $12,000 ÷ $40 per unit = 300 units 300 units × $100 selling price per unit = $30,000 breakeven sales in dollars Answer B is not correct because fixed costs change as activity level changes Answer C is correct because: Contribution margin per unit = Selling price per unit - Variable expenses per unit = $100 - $60 = $40 Contribution margin ratio = Contribution margin per unit ÷ Selling price per unit Contribution margin ratio = $40 ÷ $100 Contribution margin ratio = 40%

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**Holt Company's variable expenses are 70% of sales**

Holt Company's variable expenses are 70% of sales. At a $300,000 sales level, the degree of operating leverage is 10. If sales increase by $60,000, the degree of operating leverage will be: A) 12 B) 10 C) 6 D) 4 D

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Ans: D Solution: Sales $300,000 Variable expenses ($300,000 × 70%) 210,000 Contribution margin 90,000 Fixed expenses ? Net operating income $ ? Current degree of operating leverage = Current contribution margin ÷ Current net operating income 10 = $90,000 ÷ Current net operating income Current net operating income = $90,000 ÷ 10 = $9,000 Contribution margin = Fixed expenses - Net operating income $90,000 = Fixed expenses - $9,000 Fixed expenses = $90,000 - $9,000 = $81,000 Sales ($300,000 + $60,000) $360,000 Variable expenses ($360,000 × 70%) 252,000 Contribution margin 108,000 Fixed expenses 81,000 Net operating income $ 27,000 Degree of operating leverage = Contribution margin ÷ Net operating income = $108,000/$27,000 = 4.0

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Gayne Corporation's contribution margin ratio is 12% and its fixed monthly expenses are $84,000. If the company's sales for a month are $738,000, what is the best estimate of the company's net operating income? Assume that the fixed monthly expenses do not change. A) $565,440 B) $654,000 C) $88,560 D) $4,560 D

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Ans: D Solution: Sales $738,000 Variable expenses ($738,000 × 88%) 649,440 Contribution margin ($738,000 × 12%) 88,560 Fixed expenses 84,000 Net operating income $ 4,560

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**Wilson Company prepared the following preliminary budget assuming no advertising expenditures:**

Selling price $10 per unit Unit sales ,000 Variable expenses $600,000 Fixed expenses $300,000 Based on a market study, the company estimated that it could increase the unit selling price by 15% and increase the unit sales volume by 10% if $100,000 were spent on advertising. Assuming that these changes are incorporated in its budget, what should be the budgeted net operating income? A) $175,000 B) $190,000 C) $205,000 D) $365,000 C

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**Ans: C Solution: Sales (110,000 units × $11.50) $1,265,000**

Variable expenses (110,000 units × $6*) 660,00 Contribution margin ,000 Fixed expenses ($300,000 + $100,000) ,000 Net operating income $ 205,000 * Current variable expenses ÷ Current sales in units = Variable expense per unit $600,000 ÷ 100,000 = $6 variable expense per unit

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**Data concerning Kardas Corporation's single product appear below:**

Per Unit Percent of Sales Selling price $ % Variable expenses 20% Contribution margin $ 80% The company is currently selling 8,000 units per month. Fixed expenses are $719,000 per month. The marketing manager believes that a $20,000 increase in the monthly advertising budget would result in a 180 unit increase in monthly sales. What should be the overall effect on the company's monthly net operating income of this change? A) decrease of $160 B) increase of $20,160 C) decrease of $20,000 D) increase of $160 D

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Ans: D Solution: 8,000 units 8,180 units Sales (8,000 units, 8,180 units × $140) $1,120,000 $1,145,200 Variable expenses : ($1,120,000, $1,145,200 × 20%) 224, ,040 Contribution margin = 896, ,160 Fixed expenses = 719, ,000 Net operating income = $ 177,000 $ 177,160 Increase in net operating income: $177,160 - $177,000 = $160

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