Exercise 6-4 Computing and Using the CM Ratio [LO6-3] Last month when Holiday Creations, Inc., sold 36,000 units, total sales were $317,000, total variable expenses were $259,940, and fixed expenses were $36,200. Required: 1. What is the company’s contribution margin (CM) ratio? 2. What is the estimated change in the company’s net operating income if it can increase total sales by $1,200? (Do not round intermediate calculations.)

1. 0.18

2. $216

Explanation:

The company's contribution margin is the difference between the total sales and the total variable cost. the contribution margin ratio may then be computed as the ratio of the contribution margin to the total sales.

The difference between the contribution margin and the fixed cost gives the net income.

The total sales and total variable cost are functions of  the level of activity o number of units produced and sold.

Contribution margin ratio

= ($317,000 - $259,940)/$317,000

= 0.18

The net income

= $317,000 - $259,940- $36,200

= $20,860

If the company sold 36,000 and total sales was 317,000 then the company increases sales to

= $317,000 + $1,200

= $318,200

then the number of units sold would have increased from 36,000 to

= (318,200/317,000) × 36,000

= 36,136 units

If the total variable cost for 36,000 units was $259,940 then for 36,136 units, total variable cost

= (36136/36000) × $259,940 (using intermediate figures computed without rounding off)

= $260,924

Hence net income at this level

= $318,200 - $260,924 - $36,200

= $21,076

The estimated change in the company’s net operating income

= $21,076 - $20,860

= $216

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