Manual System Computerized System Degree of Operating Leverage LINK TO TEXT Incr
ID: 2465836 • Letter: M
Question
Manual
System
Computerized
System
Degree of Operating Leverage
LINK TO TEXT
Increase in Net Income
LINK TO TEXT
Margin of Safety ratio
A. Computerized System
B. Manual System
Casas Modernas of Juarez, Mexico, is contemplating a major change in its cost structure. Currently, all of its drafting work is performed by skilled draftsmen. Rafael Jiminez, Casas’ owner, is considering replacing the draftsmen with a computerized drafting system. However, before making the change, Rafael would like to know the consequences of the change, since the volume of business varies significantly from year to year. Shown below are CVP income statements for each alternative.Manual
System
Computerized
System
Explanation / Answer
1) Degree of operating leverage =contribution margin / operating income
Manual System = $354000 / $228387 = 1.55
Computerized system = $1062000 / $228387 = 4.65
2)
Degree of operating leverage = change in operating income / change in sales
Change in sales = 116000 / 1770000 =6.554%
For Manual System
Change in operating income = 1.55 x change in sales = 1.55 x 6.554% = 9.831%
Increase in net operating income = 9.831% x 228387 = $22453
For Computerized System
Change in operating income = 4.65 x 6.554% = $539400 = 30.475%
Increase in operating income = 30.475% x $228387 = $69600
Computerized system will produce the higher net income due to change in sales because of its greater operating leverage.
3)
Margin of safety = Profit / Contribution margin ratio
Manual System
Contribution Margin ratio = Contribution / sales = $354000 / $1770000 = 0.20
Margin of safety = $228387 / 0.20 = $1141935
Computerized system
Contribution Margin ratio = Contribution / sales = $1062000 / $1770000 = 0.60
Margin of safety = $228387 / 0.60 = $380645
Manual system will sustain greater decline in sales as its margin of safety is higher than the computerized system
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