Question

Morton Company's contribution format income statement for last month is given below: Sales (48,000 units * $27 per unit) Variable expenses Contribution margin Pixed expenses Net operating income $ 1,296,000 907, 200 388,800 311,040 77,760 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 $8.10 per unit. However, fixed expenses would increase to a total of $699,840 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 $664,848; 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 Unit	48000
	Present
1)		Amount	Per Unit	%
	Sales	$           12,96,000.00	27	100%
	Variable Expenses	$              9,07,200.00	18.9	70%
	Contribution Margin	$              3,88,800.00	8.1	30%
	Fixed Expenses	$              3,11,040.00
	Operating Expenses	$                 77,760.00
	Proposed
		Amount	Per Unit	%
	Sales	$           12,96,000.00	27	100%
	Variable Expenses	$              5,18,400.00	10.8	40%
	Contribution Margin	$              7,77,600.00	16.2	60%
	Fixed Expenses	$              6,99,840.00
	Operating Expenses	$                 77,760.00
2a)
	Present
	Degree of Operating Leverage=Contribution Margin/Net Operating Income
	Contribution Margin=(A)	$              3,88,800.00
	Net Operating Income=(B)	$                 77,760.00
	Degree of Operating Leverage=(A)/(B)	5
	Proposed
	Degree of Operating Leverage=Contribution Margin/Net Operating Income
	Contribution Margin=(A)	$              7,77,600.00
	Net Operating Income=(B)	$                 77,760.00
	Degree of Operating Leverage=(A)/(B)	10
2b)	Dollar Sales to break even=(Fixed cost/Contribution Margin ratio)
	Present
	Fixed Cost=(A)	311040
	Contribution Margin Ratio=(B)	30%
	Dollar Sales to Break even=(A)/(B)	1036800
	Proposed
	Fixed Cost=(A)	699840
	Contribution Margin Ratio=(B)	60%
	Dollar Sales to Break even=(A)/(B)	1166400
2c)	Present
	Margin of Safety=Actual Sales-Break even Sales
	Actual Sales=(A)	1296000
	Break even Sales=(B)	1036800
	Margin of Safety=(A)-(B)	259200
	Margin of Safety%=Margin of Safety in Dollars/Actual Sales
	Margin of Safety=(A)	259200
	Actual Sales=(B)	1296000
	Margin of Safety %=(A)/(B)	20.00%
	Proposed
	Margin of Safety=Actual Sales-Break even Sales
	Actual Sales=(A)	1296000
	Break even Sales=(B)	1166400
	Margin of Safety=(A)-(B)	129600
	Margin of Safety%=Margin of Safety in Dollars/Actual Sales
	Margin of Safety=(A)	129600
	Actual Sales=(B)	1296000
	Margin of Safety %=(A)/(B)	10.00%
Ans 3)	New Equipment would results increase in contribution margin ratio, it would be beneficial for a company to install new equipment.
Ans 4)	New Units sales(48000*1.30)	62400
	New Fixed Cost	$              6,64,848.00
	New Profit($77760*1.20)	$                 93,312.00
	Unit Sales Price(same)	$                          27.00
	Sales Value=(62400*$27)	$           16,84,800.00
	Variable Expenses	?
	Profit=Sales-Variable cost-Fixed Cost
	93312=1684800-Variable cost-664848
	Variable Expenses=1684800-664848-93312	$              9,26,640.00
	New Contribution margin ratio
	Sales Value=	$           16,84,800.00	100%
	Variable Expenses	$              9,26,640.00	55%
	Contribution margin(100%-55%)	$              7,58,160.00	45%
	Dollar sales to break even=(Fixed Cost/Contribution margin ratio)=($664848/45%)	$           14,77,440.00