Last month when Holiday Creations, Inc., sold 50,000 units, total sales were $200,000

Question:

EXERCISE 4-4 Computing and Using the CM Ratio

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:
L What is the company’s contribution margin (CM) ratio?
2. Estimate the change in the company’s net operating income if it were to increase its total sales by $1,000.

Answer:

1) The formula for calculating the contribution margin ratio is

Contribution margin ratio = Unit Contribution margin / Unit selling price

Unit selling price = Total sales / Number of units
                         = $200,000 / 50,000
                         = $4

Unit variable expense = Total variable expenses / number of units
                                = $120,000 / 50,000
                                = $2.4

Contribution margin per unit = Selling price per unit – Variable cost per unit
                                          = $4 – $2.4
                                          = $1.6

Now, computing the contribution margin ratio as

Contribution margin ratio = $1.6 / $4
                                     = 0.4 or 40%

2) if the sales are increased by $1,000 then the total amount of sales comes to $201,000

Calculating the net operating income:

Sales                                $201,000
(-) variable expenses         $120,600
——————————————–
Contribution margin           $80,400
(-) Fixed costs                   $65,000
——————————————–
Net operating income         $15,400
——————————————-

Before an increase in the sales amount, the net operating income is

Sales                                   $200,000
(-) variable expenses            $120,000
——————————————–
Contribution margin              $80,000
(-) Fixed costs                      $65,000
——————————————–
Net operating income           $15,000
——————————————–

Therefore, the net operating income increases by $400.

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