Question

Precision Systems manufactures CD burners and currently sells 18,500 units annually to producers of laptop computers Jay Wilson, president of the company,anticipates a 15 percent increase in the cost per unit of direct labor on January 1of next year. He expects all other costs and expenses to remain unchanged. Wilson has asked you to assist him in developing the information he needs to formulate a reasonable product strategy for next year You are satisfied that volume is the primary factor affecting costs and expenses and have separated the semivariable costs into their fixed and variable segments. Beginning and ending inventories remain at a level of 1,000 units. Current plant capacity is 20,000 units The following are the current-year data assembled for your analysis. Sales price per unit Variable costs per unit: 18e Direct materials Direct labor Manufacturing overhead and selling and administrative expenses s 18 20 3e Contribution margin per unit (40%) Fixed costs 60 40 398,8ee Required a. What increase in the selling price is necessary to cover the 15 percent increase in direct labor cost and still maintain the current contribution margin ratio of 40 percent? b. How many units must be sold to maintain the current operating income of $350,000 if the sales price remains at $100 and the 15 KPrev4 of 4 Next

Answer 1

	Sales price per unit			$100
Less:	Variable cost per unit
	Direct materials		$10
	Direct labor		$20
	Manufacturing overhead and selling and asministrative expenses		$30	$60
	Contribution margin per unit			$40
Less:	Fixed Costs			$390,000
a. Computation of Increase in Selling Price that is necessary to cover the 15% increase in direct labor cost and to maintain the current contribution margin ratio of 40% :-
							Increase in direct labor cost	=	15% of 20	=	$3
							Let the required increase in selling price per unit			=	x
	Required selling price per unit	=	$100 + x
	Revised Contribution Margin per unit	=	$40 - $3 + x
	Required Contribution margin ratio	=	Revised Contribution Margin per unit
			Required selling price per unit
	40%	=	$40 - $3 + x
			$100 + x
	40% ($100 + x)	=	$37 + x
	$40 + 0.40x	=	$37 + x
	x - 0.40x	=	$3
	0.60x	=	$3
	x	=	3/0.60
	x	=	$5
	So, the required increase in selling price per unit	=	$5
b. Computation of No. of units to be sold to maintain current operating income of $350000 if sales price remains at $100 per unit and wage increase goes into effect:-
						Computation of Revised contribution margin :-
							Sales price per unit			$100
Less:	Variable cost per unit
	Direct materials		$10
	Direct labor (20 + 3)		$23
	Manufacturing overhead and selling and asministrative expenses		$30	$63
	Contribution margin per unit			$37
a	Fixed Expenses		$                        390,000
b	Current Operating Income (Target Profit)		$                        350,000
c	Desired Contribution (a+b)		$                        740,000
d	Contribution margin per unit		$                                  37
	Number of units to earn target profit (Sales Volume)	=	Desired Contribution
			Contribution per unit
		=	$740,000
			$37
		=	20000	units
c. Schedules of estimated operating income at full capacity before and after expansion:-
							Production Capacity will increase by 20000*25% = 5000 units
							Fixed costs will increase by the amount of depreciation on additional machinery i.e. $700000*20% = $140000
				Current Capacity	After Expansion
	Production Capacity in units			20000	25000
			Per unit	Total	Total
a	Contribution margin		$37	$                     740,000	$                     925,000
b	Fixed costs			$                     390,000	$                     530,000
c	Net Operating Income (a-b)			$                     350,000	$                     395,000
	Increase in Net operating income		$                          45,000

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