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Exam 11: Cost Behavior, Operating Leverage, and Profitability Analysis

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Question 71

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Companies A and B are in the same industry and are identical except for cost structure. At a volume of 50,000 units, the companies have equal net incomes. At 60,000 units, Company A's net income would be substantially higher than B's. Based on this information:

A) Company A's cost structure has more variable costs than B's.
B) Company A's cost structure has higher fixed costs than B's.
C) Company B's cost structure has higher fixed costs than A's.
D) At a volume of 50,000 units, Company A's magnitude of operating leverage was lower than B's.

E) A) and C)
F) B) and D)

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Question 72

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Ecco Company has total fixed costs of $5,000, sells a product whose contribution margin is $50 and selling price per unit is $125, and has current sales of $15,000. The company's margin of safety ratio is 20%.

A) True
B) False

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Question 73

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Columbus Industries makes a product that sells for $25 a unit. The product has a $5 per unit variable cost and total fixed costs of $9,000. At budgeted sales of 2,000 units, the margin of safety ratio is:

In the graph below, which depicts the relationship between units produced and total cost, the dotted line depicts which type of total cost?

As activity increases, the fixed cost per unit increases while the variable cost per unit remains constant.

Once sales reach the break-even point, each additional unit sold will:

The higher the magnitude of a company's operating leverage, the smaller the decrease in profit for a given percentage decrease in revenue.

The magnitude of operating leverage for Blue Ridge Corporation is 3.5 when sales are $200,000 and net income is $36,000. If sales decrease by 6%, net income is expected to decrease by what amount?

To attain a target profit, the total gross margin generated from sales must be sufficient to cover total fixed costs plus the target profit.

Contribution margin income statements for two competing companies are provided below: $\begin{array} { |l|l|l| } \hline &{ \text { Yin Company } } & { \text { Yang Company } } \\\hline \text { Revenue } & \$ 750,000 & \$ 750,000 \\\hline \text { Less variable cosrts } & \underline{300,000} & \underline{525,000} \\\hline \text { Contribution margin } & \$ 450,000 & \$ 225,000 \\\hline \text { Less fixed costs } & \underline{405,000} & \underline{180,000} \\\hline \text { Net income } & \$ 45,000 & \$ 45,000 \\\hline\end{array}$ Required: 1) Show each company's cost structure by inserting the percentage of the company's revenue represented by each item on the contribution income statement. 2) Compute each company's magnitude of operating leverage. 3) Using the operating leverage measures computed in requirement 2, determine the increase in each company's net income (percentage and amount) if each company experiences a 10 percent increase in sales. 4) Assume that sales are expected to continue to increase for the foreseeable future, which company probably has more desirable cost structure? Why?

In order to prepare a contribution format income statement:

Gamble Company has contribution margin of $20 per unit and a break-even point of 10,000 units. If Gamble sells 9,999 units, what would be its net income or loss? Explain how you calculated your answer.

The following income statements are provided for Li Company's last two years of operation: Assuming that cost behavior did not change over the two year period, what is the annual amount of the company's fixed manufacturing overhead?

Wham Company sells electronic squirrel repellants for $60. Variable costs are 60% of sales and total fixed costs are $40,000. What is the firm's magnitude of operating leverage if 2,000 units are sold?

What are mixed or semivariable costs? Give an example of a mixed cost.

Martinez Company sells one product that has a sales price of $20 per unit, variable costs of $8 per unit, and total fixed costs of $200,000, what is the contribution margin ratio?

Rocky Mountain Bottling Company produces a soft drink that is sold for a dollar. At production and sales of 800,000 units, the company pays $600,000 in production costs, half of which are fixed costs. At that volume, general, selling, and administrative costs amount to $250,000 of which $70,000 are fixed costs. What is the amount of contribution margin per unit?

Companies with low operating leverage will experience lower profits when sales increase than will companies with higher operating leverage.

The BRC Company is considering the introduction of a new line of high end electronics. Because there is considerable uncertainty with regard to the demand for the products, the company would probably be served better by a variable cost structure.

Operating leverage exists when: