Royal Bikes (RB) manufactures and sells two models of bike, Ezee and Focus. Of RB’s sales, 60% are for EZee and 40% for Focus. RB incurs $918,000 fixed costs, and pays taxes at a rate of 40%. Sheldon Wright, the owner of RB, anticipates that the labour and material costs will increase next year. He is considering upgrading the existing machine, which will cost $72,000. However, the variable costs will reduce from $500 to $400 for Ezee and from $900 to $800 for Focus.

REQUIRED

A. Assuming the sales mix is constant, calculate the contribution margin for the composite.
B. How many units of each model of bike should be sold to break even?
C. If RB’s target after-tax income is $135,000, how many units of each model of bike should be sold?
D. In preparing a budget for next year, if RB proceeds with the new cost structure, calculate the contribution margin for the composite. What is the sales break even in units for each model?
E. With the new cost structure, if RB’s target after-tax income is $135,000, how many units of each model of bike should be sold?
F. Based on the above information, does the degree of operating leverage increase or decrease after the change in the cost structure? What insights do you gain from the change of the cost structure? Should RB proceed with the change of the cost structure?