1. Compute ( a ) the CM ratio and the break-even point in skateboards, and ( b ) the degree of oper- ating leverage at last year’s level of sales. 2. Due to an increase in labor rates, the company estimates that variable costs will increase by $3 per skateboard next year. If this change takes place and the selling price per skateboard remains constant at $37.50, what will be the new CM ratio and the new break-even point in skateboards? 3. Refer to the data in (2) above. If the expected change in variable costs takes place, how many skateboards will have to be sold next year to earn the same net operating income, $120,000, as last year?
Tyrene Products manufactures recreational equipment. One of the company’s products, a skate-
board, sells for $37.50. The skateboards are manufactured in an antiquated plant that relies heavily
on direct labor workers. Thus, variable costs are high, totaling $22.50 per skateboard of which
60% is direct labor cost.
Over the past year the company sold 40,000 skateboards, with the following operating results:
| Sales (40,000 skateboards) | $1,500,000 |
| Variable expenses | 900,000 |
| Contribution margin | 600,000 |
| Fixed expenses | 480,000 |
| Net operating income | $ 120,000 |
Management is anxious to maintain and perhaps even improve its present level of income from the
skateboards.
Required:
1. Compute ( a ) the CM ratio and the break-even point in skateboards, and ( b ) the degree of oper-
ating leverage at last year’s level of sales.
2. Due to an increase in labor rates, the company estimates that variable costs will increase by
$3 per skateboard next year. If this change takes place and the selling price per skateboard
remains constant at $37.50, what will be the new CM ratio and the new break-even point in
skateboards?
3. Refer to the data in (2) above. If the expected change in variable costs takes place, how many
skateboards will have to be sold next year to earn the same net operating income, $120,000, as
last year?
4. Refer again to the data in (2) above. The president has decided that the company may have
to raise the selling price of its skateboards. If Tyrene Products wants to maintain the same
CM ratio as last year, what selling price per skateboard must it charge next year to cover the
increased labor costs?
5. Refer to the original data. The company is considering the construction of a new, automated
plant. The new plant would slash variable costs by 40%, but it would cause fixed costs to
increase by 90%. If the new plant is built, what would be the company’s new CM ratio and
new break-even point in skateboards?
6. Refer to the data in (5) above.
a. If the new plant is built, how many skateboards will have to be sold next year to earn the
same net operating income, $120,000, as last year?
b. Assume that the new plant is constructed and that next year the company manufactures
and sells 40,000 skateboards (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.
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