Question

Morton Company's contribution format income statement for last month is given below: Sales (15,000 units X $30 per unit) Variable expenses Contribution margin Fixed expenses Net operating income $450,000 315,000 135,000 90,000 $ 45,000 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 operation Variable expenses would be reduced by $9 per unit. However, fixed expenses would increase to a total of $225,000 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 new monthly fixed expenses would be $180,000; and its net operating income would increase by 20%. Compute the company's break-even point in dollar sales under the new marketing strategy. X Answer is complete but not entirely correct. Complete this question by entering your answers in the tabs below. Required Required Required Required 1 2 3 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 $180,000; and its net operating income would increase by 20%. Compute the company's break-even point in dollar sales under the new marketing strategy. (Do not round intermediate calculations.) Show less A New break even point in $ 36,000 X dollar sales

Answer 1

150 sales Variable Expenses Contribution Margin Fixed Expense Net Operating Loss Per unit 30.00 21.00 9.00 Units 450000 315000 135000 90000 45000 Answers Reduce the Variable cost by 9.00 1) Fixed cost Will increase to 225000 Units to be produced 15000 Morton company Contribution Income Statement Present Proposed Amount Per unit % Amount Per unit sales 450000 30.00 100% 450000 30 Variable Expenses 315000 21.00 70% 180000 12 Contribution Margin 135000 9.00 30% 270000 18 Fixed Expense 90000 225000 Net Operating Income 45000 45000 % 100% 40% 60%

D B 2) Degree of Operating Leverage = DOL DOL = Contribution Margin / Net Operating Income Present Proposed Degree of Operating Leverage 3 6 Times Break Even Point = Fixed cost / CM Ratio Present Proposed Break Even Point 300000 375000 Margin of Safety = Actual Sales - BEP Sales c) Present Proposed Margin of Safety 150000 75000 Margin of Safety % 33% 17% 3) What Factor Would you Consider in your mind to take the Decision Cyclical Movements in the Economy 4) Increase Units sales by 30% 19500 Monthly Fixed Cost 180000 Operating income Increase by 20% 54000 Sales Revenue (Units *Cost) 585000 LESS: Variable cost = Sales - Fixed cost- 351000 Operating Income Contribution Margin 234000 CM Ratio = Contribution Margin Sales / Sales 40.00% New Break Even Point in Dollars 450000 = Fixed cost / CM Ratio

= 3 6 300000 375000 Operating leverage Present Proposed Break Even point = Present Proposed Margin on safety Present Proposed Margin of Safety % Present Proposed = Contribution Margin / operating income 135000 / 45000 270000 / 45000 Fixed Cost / CMRatio 90000 / 0.3 225000 0.6 Actual Sales BEP sales 450000 300000 450000 375000 Margin of Safety / Actual sales 150000 / 450000 75000 450000 150000 75000 33% 17% 130% 19500 54000 4) Sales increased by 30% Sales Units 15000 Operating income increased by 20% Operating income 45000 Sales Revenue Units 19500 CM ratio = Contribution Margin/ 234000 / Break Even dollars Fixed cost 180000 585000 120% Selling Price 30.00 Sales 585000.00 CM raio 0.40 II 40% = II 450000