Cornerstone Exercise 16.7 (Algorithmic) Degree of Operating Leverage, Percent Change in Profit

Ringsmith Company is considering two different processes to make its productprocess 1 and process 2. Process 1 requires Ringsmith to manufacture subcomponents of the product in-house. As a result, materials are less expensive, but fixed overhead is higher. Process 2 involves purchasing all subcomponents from outside suppliers. The direct materials costs are higher, but fixed factory overhead is considerably lower. Relevant data for a sales level of 25,000 units follow:

		Process 1		Process 2
Sales		$6,850,000		$6,850,000
Varoable expenses		2,125,000		3,450,000
Contribution margin		$4,725,000		$3,400,000
Less total fixed expenses		3,626,360		1,350,000
Operating income		$1,098,640		$2,050,000
Unit selling price		$274		$274
Unit variable cost		$85		$138
Unit contribution margin		$189		$136

Required:

1. Compute the degree of operating leverage for each process. Round your answers to one decimal place. Use the rounded answers in subsequent calculations.

Process 1
Process 2

2. Suppose that sales are 20 percent higher than budgeted. By what percentage will operating income increase for each process?

Process 1		%
Process 2		%

What will be the increase in operating income for each system? Round your answers to the nearest dollar.

Process 1	$
Process 2	$

What will be the total operating income for each process? Round your intermediate calculations and final answers to the nearest dollar. Use the rounded answers in subsequent calculations.

Process 1	$
Process 2	$

3. What if unit sales are 10 percent lower than budgeted? By what percentage will operating income decrease for each process?

Process 1		%
Process 2		%

What will be the total operating income for each process? Round your answers to the nearest dollar.

Process 1	$
Process 2	$

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Partially Correct