Question

Morton Company's contribution format income statement for last month is given below Sales (46,000 unite x $29 per unit) 1,334,000 Variable expenses Contribution margin Fixed expenses Net operating income 933, 800 400,200 320,160 $80,040 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 cappcity and is studying ways of improving profits Required: s 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 $8.70 per unit. However, fixed expenses would increase to a total of $720,360 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 dolars 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 seling price, the company's ne month y fied e penses would be $510.922; 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

(1)

(2) (3) With the purchase of new equipment, net operating income remains the same, but company's fixed is more than doubled. Also company's variable cost is decreased which ultimately leads to increase in contribution margin which is a good sign for the company. As a manager, I would recommend to purchase the equipment as it makes the production process streamlined and increases the contribution margin of the company.

(4)