Margin of safety = –––––––––––––––––––––––––––––––––––––––––––––– Total budgeted sales $870,000 – $348,000 Margin of safety = ––––––––––––––––––––––– $870,000 Margin of safety = 60% 3-48 e.

Chapter 3 Analysis of Cost, Volume, and Pricing to Increase Profitability ATC 3-1 a. Operating leverage is the concept that explains how the percentage change in net earnings can increase at a faster rate than the percentage increase in revenues. b. Operating leverage exists because of fixed costs. If all of a company’s costs are variable in nature, its percent- age change in earnings will be exactly the same as its percentage change in revenue, and it will not experi- ence operating leverage. c. Of the three categories of expenses, the one that has the highest relative amount of fixed costs, and the low- est relative amount of variable costs, will be the one making the greatest contribution to operating leverage. If a cost is perfectly variable, a 10% increase in activity will cause a 10% increase in costs. For Netflix, we can compare the percentage of change in revenues from 2012 to 2014, to the percentage change in the four ex- pense categories: 2012 2014 Percent Change Revenue $ 3,609,282 $ 5,504,656 52.5% Cost of revenues 2,652,058 3,752,760 41.5% Marketing 439,208 607,186 38.2% Technology and development 329,008 472,321 43.6% General and administrative 139,016 269,741 94.0% Cost of revenues, Marketing, and Technology and develop- ment all increased at a lower rate than the increase in Rev- enues, suggesting that each of these have some fixed costs components, thus contributing to operating lever- age. Of these three costs, Marketing increased the least, suggesting it has the most fixed cost element, but. it is relatively small compared to Cost of revenues. 3-49

Chapter 3 Analysis of Cost, Volume, and Pricing to Increase Profitability Of particular interest is the 94 percent increase in General and administrative cost versus the 52.5 percent in- crease in revenue. This suggests that between 2012 and 2014, these costs increased to a point that they were no longer in a “relevant range.” ATC 3-2 a. and b. Alternatives Original 1 2 3 Revenue $8,000 $12,800 $7,600 $7,200 Variable costs (4,800) (7,680) (3,040) (4,320) Contribution margin 3,200 5,120 4,560 2,880 Fixed cost (2,400) (4,000) (2,400) (1,600) Net income $ 800 $1,120 $2,160 $1,280 Answers can be determined rapidly by multiplying the contribution margin per unit by the number of units sold and subtracting fixed cost. c. The discussion will take many forms. However, it is likely that lead- ership will be decided by action. The people who aggressively step forward are usually given authority. In general, power is taken, not given. Also, division of labor should be discussed. In all likelihood the section that won divided the three tasks among different groups. Each group only did part of the total task. It is highly inef- ficient to have each group do all of the tasks.