Question

Magic Realm, Incorporated, has developed a new fantasy board game. The company sold 25,500 games last year at a selling price of $60 per game. Fixed expenses associated with the game total $425,000 per year, and variable expenses are $40 per game. Production of the game is entrusted to a printing contractor. Variable expenses consist mostly of payments to this contractor. Required: 1-a. Prepare a contribution format income statement for the game last year. 1-b. Compute the degree of operating leverage. 2. Management is confident that the company can sell 31,110 games next year (an increase of 5,610 games, or 22%, over last year). Given this assumption: a. What is the expected percentage increase in net operating income for next year

Answer 1

1.a. Magic Realm, Incorporated's Contribution-format Income Statement for last year is as follows:

Sales Revenue        $1,530,000 (25,500 x $60)

Variable costs           1,020,000 (25,500 x $40)

Contribution margin  $510,000 (25,500 x $20)

Fixed costs               $425,000

Operating income    $85,000

1-b) The degree of operating leverage = Change in operating income/Change in Sales

= $85,000/$1,530,000 x 100

= 5.56%

2. Magic Realm, Incorporated expected percentage increase in net operating income should be equal to 132%.

Data and Calculations:

Number of games sold last year = 25,500 games

Selling price per game = $60

Variable cost per game = $40

Contribution margin per game = $20 ($60 - $40)

Fixed cost = $425,000

Contribution margin for next year = $622,200 (31,110 x $20)

Fixed costs = $425,000

Net operating income = $197,200 ($622,200 - $425,000)

Increase in operating income = $112,200 ($197,200 - $85,000)

Percentage increase = 132% ($112,200/$85,000)

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