Question

Problem 5-29 Changes in Cost Structure; Break-Even Analysis; Operating Leverage; Margin of Safety [LO5-4, LO5-5, LO5-7, LO5-8]

Morton Company’s contribution format income statement for last month is given below:

Sales (49,000 units × $28 per unit)	$	1,372,000
Variable expenses		960,400
Contribution margin		411,600
Fixed expenses		329,280
Net operating income	$	82,320

The industry in which Morton Company operates is quite sensitive to cyclical movements in the economy. Thus, profits vary considerably from year to year according to general economic conditions. The company has a large amount of unused capacity and is studying ways of improving profits.

Required:

1. New equipment has come onto the market that would allow Morton Company to automate a portion of its operations. Variable expenses would be reduced by $8.40 per unit. However, fixed expenses would increase to a total of $740,880 each month. Prepare two contribution format income statements, one showing present operations and one showing how operations would appear if the new equipment is purchased.

2. Refer to the income statements in (1). For the present operations and the proposed new operations, compute (a) the degree of operating leverage, (b) the break-even point in dollar sales, and (c) the margin of safety in dollars and the margin of safety percentage.

3. Refer again to the data in (1). As a manager, what factor would be paramount in your mind in deciding whether to purchase the new equipment? (Assume that enough funds are available to make the purchase.)

4. Refer to the original data. Rather than purchase new equipment, the marketing manager argues that the company’s marketing strategy should be changed. Rather than pay sales commissions, which are currently included in variable expenses, the company would pay salespersons fixed salaries and would invest heavily in advertising. The marketing manager claims this new approach would increase unit sales by 30% without any change in selling price; the company’s new monthly fixed expenses would be $525,476; and its net operating income would increase by 20%. Compute the company's break-even point in dollar sales under the new marketing strategy.

Answer 1

sales Variable Expenses Contribution Margin Fixed Expense Net Operating Loss Per unit 28.00 19.60 8.40 49000 Units 1372000 960400 411600 329280 82320 Answers Reduce the Varaibe cost by 8.40 Fixed cost Will increase to 740880 Units to be porduced 49000 Motron company Contribution Income Statement Present Proposed Amount Per unit % Amount Per unit 1372000 28.00 100% 1372000 28 Variable Expenses 960400 19.60 70% 548800 11.2 Contribution Margin 411600 8.40 30% 823200 16.8 Fixed Expense 329280 740880 Net Operating Income 82320 82320 % sales 100% 40% 60%

JA Degree of Operating Leverage = DOL DOL = Contiburion Margin / Net Operating Income Present Prososed Degree of Operating Leverage 10 Times Break Evein Point = Fixed cost / CM Ratio Present Prososed Break Even Point 1097600 | 1234800 Margin of Safety = Actula Sales - BEP Sales Present Prososed Margin of Safety 274400137200 Margin of Safety % 20% 10% 3) What Factor Would you Consider in youy mind to take the Decision Cyclical Movements in the Economy 4) Increase Units sales by 30% 63700 Monthly Fixed Cost 525476 | Operating income Increase by 20% 98784) Sales Revneue (Units Cost) 1783600 Variable cost = Sales - Fixed cost - Operating 1159340 Income Contribution Margin 624260 CM Ratio = Contibiton Margin Sales / Sales 35.00% New Break EvenPoint in Dollars 1501360 = Fixed cost / CM Ratio