Chapter 6, Problem 6.15E

Casas Modernas of Juarez, Mexico, is contemplating a major change in its cost structure. Currently, all of its drafting work is performed by skilled draftsmen. Rafael Jiminez. Casas' owner, is considering replacing the draftsmen with a computerized drafting system. However, before making the charge. Rafael 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.

Compute degree of operating leverage and evaluate impact of alternative cost structures on net income and margin of safety.

(LO 4). AN

	Manual System	Computerized System
Sales	$1,500,000	$1,500,000
Variable costs	1,200,000	600,000
Contribution margin	300,000	900,000
Fixed costs	100,000	700,000
Net income	$ 200,000	$ 200,000

Instructions

(a) Determine the degree of operating leverage for each alternative.

(b) Which alternative would produce the higher net income if sales increased by $150,000?

(c) Using the margin of safety ratio, determine which alternative could sustain the greater decline in sales before operating at a loss.