Question

Exercise 5-5 Changes in Variable Costs, Fixed Costs, Selling Price, and Volume [LO5-4]

[The following information applies to the questions displayed below.]

Data for Hermann Corporation are shown below:

	Per Unit				Percent of Sales
Selling price	$	135				100	%
Variable expenses		81				60
Contribution margin	$	54				40	%

Fixed expenses are $87,000 per month and the company is selling 2,900 units per month.

Garrison 16e Rechecks 2017-05-02

Exercise 5-5 Part 1

Required:

1-a. How much will net operating income increase (decrease) per month if the monthly advertising budget increases by $9,200 and monthly sales increase by $21,000?

1-b. Should the advertising budget be increased?

yes

no

2-a. Refer to the original data. How much will net operating income increase (decrease) per month if the company uses higher-quality components that increase the variable expense by $5 per unit and increase unit sales by 20%.

2-b. Should the higher-quality components be used?

yes

no

Answer 1

1-a.

Net operating income (loss) = ($21,000 X 40%) - $9,200 = ($800)

Net operating income will reduce by $800

1-b.

No. Advertising budget should not be increased.

2-a.

Current operating income = (2,900 X $135 X 40%) - $87,000 = $69,600

Operating income = [2,900 + 20% ($135 - $81 - $5)] - $87,000 = $83,520

Increase in net operating income = $83,520 - $69,600 = $13,920

2-b.

Yes. Higher quality component should be used.