Question

For nearly 20 years, Specialized Coatings has provided painting and galvanizing services for manufacturers in its region. Manufacturers of various metal products have relied on the quality and quick turnaround time provided by Specialized Coatings and its 20 skilled employees. During the last year, as a result of a sharp upturn in the economy, the company’s sales have increased by 30% relative to the previous year. The company has not been able to increase its capacity fast enough, so Specialized Coatings has had to turn work away because it cannot keep up with customer requests.

Top management is considering the purchase of a sophisticated robotic painting booth. The booth would represent a considerable move in the direction of automation versus manual labor. If Specialized Coatings purchases the booth, it would most likely lay off 15 of its skilled painters. To analyze the decision, the company compiled production information from the most recent year and then prepared a parallel compilation assuming that the company would purchase the new equipment and lay off the workers. Those data are shown below. As you can see, the company projects that during the last year it would have been far more profitable if it had used the automated approach.

		Current Approach		Automated Approach
Sales		$1,840,000		$1,840,000
Variable costs		1,380,000		920,000
Contribution margin		460,000		920,000
Fixed costs		345,000		726,800
Net income		$115,000		$193,200

Compute the contribution margin ratio under each approach. Current approach Automated approach Contribution margin ratio % % LINK TO TEXT

Compute the break-even point in sales dollars under each approach. Current approach Automated approach Break-even points in sales dollars $ $ LINK TO TEXT

Using the current level of sales, compute the margin of safety ratio under each approach. Current approach Automated approach Margin of safety ratio % % LINK TO TEXT

Determine the degree of operating leverage for each approach at current sales levels. (Round answers to 2 decimal places, e.g. 2.25.) Current approach Automated approach Degree of operating leverage How much would the company’s net income decline under each approach with a 10% decline in sales? (Round answers to 1 decimal place, e.g. 22.5%.) For a 10% drop in sales net income would increasedecrease by % for Current approach For a 10% drop in sales net income would increasedecrease by % for Automated approach LINK TO TEXT

At what level of sales would the company’s net income be the same under either approach? Net income would be equal to $ sales

Answer 1

Solution: a) Contribution margin / Sales Contribution margin ratio Current Approach Automated Approach 460000 920000 1840000 1840000 25.00% 50.00% b) Fixed costs / Contribution margin ratio Break-even points in sales dollars Current Approach Automated Approach 345000 726800 25.00% 50.00% 1380000.00 1453600.00 Current sales Less : Break-even points in sales dollars Margin of safety in dollars / Current sales Margin of safety ratio Current Approach Automated Approach 1840000 1840000 -1380000 -1453600 460000.00 386400.00 1840000 1840000 25.00% 21.00% Contribution margin / Net operating income Degree of operating leverage Current Approach Automated Approach 460000 920000 115000 193200 4.00 4.76 Decline in sales x Degree of operating leverage net income would decrease by Current Approach Automated Approach 10% 10% 4.00 4.76 40.00% 47.62% Net income-Sales* CM ratio-Fixed cost Let the sales be'a' 0.25a-345000=0.50a-726800 0.25a=381800 a=381800/0.25 1527200