# 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.

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.