Question

Required information Exercise 2-5 (Algo) Changes in Variable Costs, Fixed Costs, Selling Price, and Volume [LO2-4] [The following information applies to the questions displayed below.) Data for Hermann Corporation are shown below: Per Unit $ 75 Percent of Sales 100% 68 Selling price Variable expenses Contribution margin 51 $ 24 32% Fixed expenses are $75,000 per month and the company is selling 4,000 units per month. Exercise 2-5 (Algo) Part 1 Required: 1-a. How much will net operating income increase (decrease) per month if the monthly advertising budget increases by $9,900 and monthly sales increase by $24,500? 1-b. Should the advertising budget be increased?

Answer 1

Answer 1-a:

Increase in Fixed Expense = $9,900
Increase in Sales = $24,500
Contribution Margin Ratio = 32%

Increase in Net Operating Income = Increase in Sales * Contribution Margin Ratio - Increase in Fixed Expense
Increase in Net Operating Income = $24,500 * 0.32 - $9,900
Increase in Net Operating Income = -$2,060

Answer 1-b:

The advertising budget should not be increased as net operating income will decrease.

Answer 2-a:

Before changes:

Net Operating Income = Units Sold * Contribution Margin per unit - Fixed Expenses
Net Operating Income = 4,000 * $24.00 - $75,000
Net Operating Income = $21,000

After changes:

Selling Price per unit = $75.00

Variable Cost per unit = $51.00 + $4.00
Variable Cost per unit = $55.00

Contribution Margin per unit = Selling Price per unit - Variable Cost per unit
Contribution Margin per unit = $75.00 - $55.00
Contribution Margin per unit = $20.00

Units Sold = 4,000 + 25% * 4,000
Units Sold = 5,000

Fixed Expenses = $75,000

Net Operating Income = Units Sold * Contribution Margin per unit - Fixed Expenses
Net Operating Income = 5,000 * $20.00 - $75,000
Net Operating Income = $25,000

Increase in Net Operating Income = $25,000 - $21,000
Increase in Net Operating Income = $4,000

Answer 2-b:

The higher-quality component should be used as net operating income will increase.