Question

Problem 2-29 (Algo) Changes in Cost Structure; Break-Even Analysis; Operating Leverage; Margin of Safety (L02-4, LO2-5, LO2-7, LO2-8] Morton Company's contribution format income statement for last month is given below: Sales (48,000 units x $28 per unit) Variable expenses Contribution margin Fixed expenses Net operating income $ 1,344,000 940, 800 403, 200 322,560 $ 80,640 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 $8.40 per unit. However, fixed expenses would increase to a total of $725,760 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 bv 30% without any change in sellina price: the company's new monthly fixed expenses would be $689.472: and its

Answer 1

excel formulae sheet

H 1 Requirement 1) % 6 Sales 7 Less variable expense 8 Contribution 9 Fixed expense 10 Net income Morton Company Contributon income statement Present amount per unit 1344000 28 9408001 19.6 4032001 8.4 322560 80640 100% 70 % 30% Proposed amount per unit % 1344000 28 537600 11.2 806400 8.4 725760 80640 100% 40% 60% Present Proposed 10 12 Requirement 2) 13 Degree of operating leverage = contibution/net income 14 15 Degree of operating leverage 16|2a)break even point in dollars = fixed cost contribution ratio 17 18 BEP(dollars) 19 20 c) margin of safety in dollars = actual sales - BEP in dollars 21 margin of safety % = margin of safety/ actual sales Present 10752001 Proposed 1209600 24 Margin of safety 25 Margin of safety percentage Present 268800 20% Proposed 134400 10% 26 62.400 28 273) Cyclical movements in economy 28 29 4) 30 Sales units (48000*130%) 31 Sale price 32 Sales revenue (62400*28) 33 Less : Variable expense 34 Contribution 35 Fixed expense 36 Net income (68880*125%) 1747200 960960 786240 689472 96768 28/ 100% 15.4 55% 12.6 45% 37 38 Contribution = Net income + Fixed expense 39 Variable expense = Sales - Contribution 40 New break even point in dollar sales = 689472/45% 41 = 1532160

1 Requirement 1) Morton Company Contributon income statement Present amount per unit 6 Sales 1344000 28 =C6/SCS6*100 % 7 Less variable expense 940800 =C7/48000 =C7/$C$6*100 % 8 Contribution =C6-C7 =C8/48000 =C8/SC$6*100% 9 Fixed expense 322560 10 Net income =C8-C9 11 12 Requirement 2) 13 Degree of operating leverage = contibution/net income Present Proposed 15 Degree of operating leverage =C8/C10 =G8/G10 16 2a)break even point in dollars = fixed cost contribution ratio Present Proposed 18 BEP(dollars) =C9/C8/C6) =G9/(G8/G6) Proposed amount per unit 1344000 28 =G6/SGS6*100 % =H7*48000 =D7-8.4 =G7/$G$6*100 % =G6-G7 8.4 =G8/SG$6*100% 725760 =G8-G9 17 20 c) margin of safety in dollars = actual sales - BEP in dollars 21 margin of safety % = margin of safety/ actual sales 22 23 24 Margin of safety 25 Margin of safety percentage Present =C6-D18 =D24/C6 Proposed =G6-F18 =F24/G6 26 27 3) Cyclical movements in economy 28 =48000*130% 28 29 4) 30 Sales units (48000*130%) 31 Sale price 32 Sales revenue (62400*28) 33 Less : Variable expense 34 Contribution 35 Fixed expense 36 Net income (68880*125%) 1=62400*28 =F32-F34 =F35+F36 689472 =C10*120% 28 =H33+H34 =F33/62400 =F33/SFS32 =F34/62400 =F34/$F$32 37 38 Contribution = Net income + Fixed expense 39 Variable expense = Sales - Contribution 40 New break even point in dollar sales = 689472/45% L = 1532160 41