Question

Morton Company's contribution format income statement for last month is given below: $ Sales (41,000 units X $21 per unit) Variable expenses Contribution margin Fixed expenses Net operating income 861,000 602,700 258,300 206,640 51,660 $ 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 $6.30 per unit. However, fixed expenses would increase to a total of $464,940 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

Answer 1

Part 1
	Morton Company
	Contribution Income Statement
		Present	Proposed
		Amount	Per unit	Amount	Per unit
	Sales	$                     861,000	$                         21.00	$           861,000	$             21.00
	Variable Costs	$                     602,700	$                         14.70	$           344,400	$               8.40
	Contribution Margin	$                     258,300	$                           6.30	$           516,600	$             12.60
	Fixed Costs	$                     206,640		$           464,940
	Net Operating Income	$                       51,660		$             51,660
Part 2		Present	Proposed
a	Degree of Operating Leverage(Contribution Margin/Net operating income)	5	10
b	Break-even Point in $(Fixed Costs / Contribution Margin ratio)	$                     688,800	$                     774,900
c	Margin of Safety in dollars(Sales Revenue - Break-even Point in $)	$                     172,200	$                       86,100
	Margin of Safety in percentage(Margin of Safety / Sales Revenue)	20.00%	10.00%
Part 3	As a manager stock level maintained shall be considered while making a decision
Part 4	Unit Sales(41,000 unit*1.30)	53300
	New Sales(53,300 units*$21)	$                  1,119,300
	New Operating Income($51,660*1.20)	$                       61,992
	Add:Fixed expenses	$                     385,728
	New Contribution Margin	$                     447,720
	New Sales(53,300 units*$21)	$                  1,119,300
	Less:New Contribution Margin	$                     447,720
	New Variable expenses	$                     671,580
	Variable expenses per unit($671,580/53300 units)	$                         12.60
	New Contribution Margin per unit($21-$12.60)	$                           8.40
	Contribution Margin ratio($8.40/$21)	40.00%
	Break-even Point in $(Fixed Costs / Contribution Margin ratio)	$                     964,320