Magic Realm, Inc., has developed a new fantasy board game. The company sold 19,800 games last year at a selling price of $68 per game. Fixed expenses associated with the game total $297,000 per year, and variable expenses are $48 per game. Production of the game is entrusted to a printing contractor. Variable expenses consist mostly of payments to this contractor.

Magic Realm, Inc., has developed a new fantasy board game. The company sold 19,800 games last year at a selling price of $68 per game. Fixed expenses associated with the game total $297,000 per year, and variable expenses are $48 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 24,948 games next year (an increase of 5,148 games, or 26%, over last year). Given this assumption:

a. What is the expected percentage increase in net operating income for next year?

b. What is the expected amount of net operating income for next year? (Do not prepare an income statement; use the degree of operating leverage to compute your answer.)

Explanation

1-a.

Sales: 19,800 games × $68 = $1,346,400

1-b.

The degree of operating leverage is:

Degree of operating leverage	=	Contribution margin
		Net operating income
	=	$396,000	= 4
		$99,000

2.

a.

Sales of 24,948 games represent a 26% increase over last year’s sales. Because the degree of operating leverage is 4, net operating income should increase by 4 times as much, or by 104% (4 × 26%).

b.

The expected total dollar amount of net operating income for next year would be:

Last year’s net operating income	$	99,000
Expected increase in net operating income next year (104% × $99,000)		102,960
Total expected net operating income	$	201,960

Here