Question

Problem 2-29 (Algo) Changes in Cost Structure; Break-Even Analysis; Operating Leverage; Margin of Safety [LO2-4, LO2-5, LO2-7, LO2-8] Morton Company's contribution format income statement for last month is given below: $ Sales (43,000 units X $22 per unit) Variable expenses Contribution margin Fixed expenses Net operating income 946,000 662,200 283,800 227,040 56, 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 $6.60 per unit. However, fixed expenses would increase to a total of $510,840 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 $485,298; 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

Answers Reduce the Varaibe cost by 6.6 Fixed cost will increase to 510840 Units to be porduced 43000 Motron company Contribution Income Statement Present Amount Per unit % Amount sales 946000 22.00 100% 946000 Variable Expenses 662200 15.40 70% 378400 Contribution Margin 283800 30% 567600 Fixed Expense 227040 510840 Net Operating Income 56760 56760 % Proposed Per unit 22 8.8 13.2 100% 40% 60% 6.60 L

2) Degree of Operating Leverage = DOL DOL - Contiburion Margin / Net Operating Income Present Prososed 10 Degree of Operating Leverage Times Break Evein Point = Fixed cost/CM Ratio Present Prososed Break Even Point 756800 851400 Margin of Safety = Actula Sales - BEP Sales Present Prososed Margin of Safety 18920094600 Margin of Safety % 20% 10% 13) What Factor Would you Consider in youy mind to take the Decision Cyclical Movements in the Economy 4) | Increase Units sales by | 30% 55900 Monthly Fixed Cost 485298 Operating income Increase by 20% 68112 Sales Revneue (Units Cost) 1229800 Variable cost = Sales - Fixed cost - Operating 676390 Income Contribution Margin 553410 CM Ratio = Contibiton Margin Sales / Sales 45.00% New Break EvenPoint in Dollars 1078440 = Fixed cost / CM Ratio