Head-First Company had planned to sell 5,000 bicycle helmets at $75 each in the coming year. Unit variable cost is $45 (includes direct materials, direct labor, variable factory overhead, and variable selling expense). Total fixed cost equals $49,500 (includes fixed factory overhead and fixed selling and administrative expense). Operating income at 5,000 units sold is $100,500. The degree of operating leverage is 1.5. Now Head-First expects to increase sales by 10% next year.

Required:

1. Calculate the percent change in operating income expected.___ %

2. Calculate the operating income expected next year using the percent change in operating income calculated in Requirement 1. $___

Instructions are listed below.

Explanation:

Giving the following information:

Sales= 5,000 units

Selling price= $75

The unit variable cost= $45

Total fixed cost equals= $49,500

Operating income at 5,000 units sold is $100,500.

Degree of operating leverage= 1.5

Now Head-First expects to increase sales by 10% next year.

1) % Change on income= ?

We know that the degree of operating leverage is calculated by the following formula:

degree of operating leverage= %change in income/ %change in sales

1.5= %change in income/0.10

0.15= %change in income

15%= %change in income

2) Net operating income

Sales= 5,500*75= 412,500

Total variable cost= 5,500*45= (247,500)

Contribution margin= 165,000

Fixed costs= (49,500)

Net operating income= 115,500

Change in income= (115,500 - 100,500)/100,500= 0.1493= 14.93%

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