E7-34A Terry\'s Towing Service has a monthly target operating income of $30,000.
ID: 2554222 • Letter: E
Question
E7-34A Terry's Towing Service has a monthly target operating income of $30,000. Variable expenses are 40% of sales and monthly fixed expenses are $7,500
1. Compute the monthly margin of safety in dollars if the shop achieves its income goal.
2. Express Terry's margin of safety as a percentage of target sales
3. What is Terry's operating leverage factor at the target level of operating income? 4. Assume that the company reaches its target. By what percentage will the company's operating income fall if sales volume declines by 12%?
Explanation / Answer
Answer
Target Income
$30000
(+) Fixed expenses
$7500
Contribution margin
$37500
Variable cost
40% of sale
Contribution margin will be
60% of sale
Total target Sales Revenue [37500 / 60%]
$62500
Fixed expenses
$7500
Contribution margin ratio
$60%
Break Even Sale [7500/60%]
$12500
Total Sales Revenue
$62500
(-) Break Even Sales Revenue
$12500
Margin of Safety in Dollars
$50000
Margin of Safety in Dollars
$50000
Total target Sales Revenue
$62500
Margin of Safety as percentage of target Sale [50000/62500]
80%
Contribution margin [62500 x 60%]
$37500
Operating Income [Target Income]
$30000
Operating leverage [37500/30000]
1.25
Sales Volume Declines by
12%
Company's operating income will fall by [12% x Operating Leverage] = [12% x 1.25]
15%
Target Income
$30000
(+) Fixed expenses
$7500
Contribution margin
$37500
Variable cost
40% of sale
Contribution margin will be
60% of sale
Total target Sales Revenue [37500 / 60%]
$62500
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