**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.