Question

Data for Hermann Corporation are shown below:

	Per Unit				Percent of Sales
Selling price	$	100				100	%
Variable expenses		61				61
Contribution margin	$	39				39	%

Fixed expenses are $80,000 per month and the company is selling 3,700 units per month.

1-a. How much will net operating income increase (decrease) per month if the monthly advertising budget increases by $8,500 and monthly sales increase by $17,500?

1-b. Should the advertising budget be increased?

2-a. Refer to the original data. How much will net operating income increase (decrease) per month if the company uses higher-quality components that increase the variable expense by $3 per unit and increase unit sales by 15%.

2-b. Should the higher-quality components be used?

Answer 1

1.a.

	Current	Proposed
Sales	(100*3700)=$370,000	(370,000+17500)=$387500
Variable expenses	(61*3700)=225700	(387500*61%)=236375
Contribution margin	144300	151125
Fixed expenses	80,000	(80,000+8500)=88500
Net operating income	64300	62625

Hence decrease in net operating income=64300-62625

=$(1675)

b.Hence higher quality components should not be used

2.a.

	Current	Proposed
Unit sales	3700	(3700*1.15)=4255
Sales	(100*3700)=$370,000	(4255*100)=425500
Variable expenses	(61*3700)=225700	4255*(61+3)=272320
Contribution margin	144300	153180
Fixed expenses	80,000	80,000
Net operating income	64300	73180

Hence increase in net operating income=73180-64300

=$8880

b.Hence higher quality components should be used