Arquitectos Interiores of Juarez, Mexico, is contemplating a major change in its

Question

Arquitectos Interiores of Juarez, Mexico, is contemplating a major change in its cost structure. Currently, all of its drafting work is performed by skilled draftsmen. Alfonso Jiminez, Arquitectos’ owner, is considering replacing the draftsmen with a computerized drafting system. However, before making the change, Alfonso 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 Sales $1,769,000 $1,769,000 Variable costs 1,415,200 707,600 Contribution margin 353,800 1,061,400 Fixed costs 117,933 825,533 Net income $235,867 $235,867

(a) Determine the degree of operating leverage for each alternative. (Round answers to 2 decimal place, e.g. 1.25.)

(b) Calculate the increase in Net income for each alternative if sales increased by $131,000.

(c) Calculate the margin of safety ratio. (Round ratios to 2 decimal place, e.g. 0.25.)

Explanation / Answer

Particulars Manual System (Alt 1) Computerized System (Alt 2) a. Computation of Operating Leverage Sales $1,769,000.00 $1,769,000.00 Variable Cost $1,415,200.00 $707,600.00 Contribution $353,800.00 $1,061,400.00 Fixed Cost $117,933.00 $825,533.00 Net Income $235,867.00 $235,867.00 Variable cost to Sales 80% 40% Operating Leverage (Contribution Margin / Net Operating Income) $353800 / $235867 $1061400 / $235867 1.50 4.50 b. Increase in net income if sales is increase by $131,000 Revised Sales $1,900,000.00 $1,900,000.00 Revised Variable Cost (80%, 40%) $1,520,000.00 $760,000.00 Revised Contribution $380,000.00 $1,140,000.00 Fixed Cost $117,933.00 $825,533.00 Revised Net Income $262,067.00 $314,467.00 Existing Income $235,867.00 $235,867.00 Net Increase in net income $26,200.00 $78,600.00 c. Margin of Safety Ratio: Breakeven Sales (Fixed Cost / Contribution margin) $117933 / 20% $117933 / 60% $589,665 $1,375,888.33 Margin of Safety Ratio [(Current Sales - Breakeven Sales) / Current Sales] ($1,769,000 - $589,665) / $1769000 ($1,769,000 - $1,375,888.33) / $1769000 $0.67 $0.22

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