Question

Problem 5-29 Changes in Cost Structure; Break-Even Analysis; Operating Leverage; Margin of Safety [LO5-4, L05-5, LO5-7, LO5-8 Morton Company's contribution format income statement for last month is given below: Sales (47,000 units x $25 per unit) Variable expenses Contribution margin Fixed expenses Net operating income $ 1,175,000 822,50 352,50e 282,000 70,500 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 $7.50 per unit. However, fixed expenses would increase to a total of $634,500 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 $450,025; and its net operating income would increase by 20%. Compute the company's break-even point in dollar sales under the new marketing strategy Complete this question by entering your answers in the tabs below Required Required 2 Required 3 Required 4 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 $7.50 per unit. However, fixed expenses would increase to a total of $634,500 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. (Round "Per Unit" to 2 decimal places.) Show less Morton Company Contribution Income Statement Present Proposed Per Unit Amount Per Unit Amount

Answer 1

Part-1
Morton Company
Contribution Income Statement
	Present			Proposed
	Amount	Per unit	%	Amount	Per unit	%
Sales	$11,75,000.00	$25.00	100%	$11,75,000.00	$25.00	100%
Variable Expenses	$8,22,500.00	$17.50	70%	$4,70,000.00	$10.00	40%
Contribution margin	$3,52,500.00	$7.50	30%	$7,05,000.00	$15.00	60%
Fixed expenses	$2,82,000.00			$6,34,500.00
Net operating income	$70,500.00			$70,500.00

2a.

Degree of operating leverage = Contribution margin / Net operating income

Present degree of operating leverage = $352500/$70500 = 5

Proposed degree of operating leverage = $705000/$70500 = 10

Part-2b

Breakeven dollar sales = Fixed cost/Contribution margin ratio

Present breakeven dollar sales = $282,000/30% = $940,000

Proposed breakeven dollar sales = $634500/60% = $1,057500

Part-2C

Margin of safety dollar sales = Total sales – Breakeven dollar sales

Margin of safety in percentage = Margin of safety sales/ Total sales

Present

Margin of safety dollar sales = $11,75,000-$940,000 = $235,000

Margin of safety in percentage = $235,000/$1,175,000 = 20%

Proposed

Margin of safety dollar sales = $1,175000-$1,057,500 = $117500

Margin of safety in percentage = $117500/$1,175,000 = 10%

Part-3

Answer is :”Cyclical movements in the economy”

Part-4

New sales = $1,175,000 * 130% = $1,527,500

New net operating income = $70,500 * 120% = $84600

New fixed expenses = $450,025

New Contribution margin = New fixed expenses + new net operating income = $450025 + $84600 = $534625

New Contribution margin ratio = $534625/$1,527,500 = 35%

New breakeven dollar sales = New fixed costs/New contribution margin ratio = $450025/35% = $1285786