Question

Required information [The following information applies to the questions displayed below.] Data for Hermann Corporation are shown below: Selling price Variable expenses Contribution margin Percent Per Unit of Sales $ 90 100% 63 $ 27 3 0 70 Fixed expenses are $30,000 per month and the company is selling 2,000 units per month. Required: 1-a. How much will net operating income increase (decrease) per month if the monthly advertising budget increases by $5,000 and monthly sales increase by $9,000? 1-b. Should the advertising budget be increased? Complete this question by entering your answers in the tabs below. Req 1A Req 1B How much will net operating income increase (decrease) per month if the monthly advertising budget increases by $5,000 and monthly sales increase by $9,000? Net operating income < Req1A Req1B >

Answer 1

Ans. 1 a	Net operating income decrease by $2,300.
	*Explanations and calculations:
	Advertising is a fixed expense, so fixed expenses will increase by the amount
	of $5,000.
	*First of all we will calculate incremental contribution margin then incremental
	fixed expenses will be deducted from this to calculate the increase or decrease
	in net operating income.
	*Incremental contribution margin = Increase in sales * Contribution margin ratio
	$9,000 * 30%
	$2,700
	Particulars	Amount
	Incremental Contribution margin	$2,700
	Less: Incremental Fixed cost	-$5,000
	Decrease in net operating income	-$2,300
Ans. 1 b	No, the advertising budget should not be increased as this will decrease
	the net operating income by $2,300.
Ans. 2 a	Net operating income increase by $14,000.
	*Explanations and calculations:
	Incremental selling price ($90 * 10%)	$9.00
	Less: Incremental variable cost per unit	-$2.00
	Incremental contribution margin per unit	$7.00
	*Incremental contribution margin = Incremental contribution margin per unit * Units sold
	$7.00 * 2,000
	$14,000
	*No increase in fixed expenses.
	Particulars	Amount
	Incremental Contribution margin	$14,000
	Less: Incremental Fixed cost	$0
	Increase in net operating income	$14,000
Ans. 2 b	Yes, the high quality components should be used as these will increase
	the net operating income by $14,000.
	*WORKING NOTES:
	Income Statement using original data:
	HERMANN   CORPORATION
	CVP Income Statement
		Total	Per unit
	Sales (2,000 *p)	$180,000	$90.00
	Variable expenses (2,000 * v)	-$126,000	-$63.00
	Contribution margin	$54,000	$27.00
	Fixed expenses	-$30,000
	Net operating income	$24,000
	P   =   price per unit
	V = variable cost per unit