Question

ADAM Corporation currently produces and sells a single product. Data concerning that product appear below: Per Unit Percentage Selling price $200 100% Variable expenses 60 30% Contribution margin $140 70% Fixed expenses are $280,000 per month. The company is currently selling 7,000 units per month. Proposed situation: The marketing manager would like to introduce sales commissions as an incentive for the sales staff. The marketing manager has proposed adding a commission (variable cost) of $10 per unit. In exchange, the sales staff would accept an overall decrease in their salaries of $33,000 per month. The marketing manager predicts that introducing this sales incentive would increase monthly sales by 200 units. Required: 1) Compare the break-even in units under both the existing and proposed situation. 2) Compare the margin of safety in dollars (level of sales in dollars less break-even sales in dollars) under both the existing and proposed situation. 3) Compare the monthly net operating income under both the existing and proposed situation? 4) Based on your previous comparison, which situation will you recommend (existing or proposed)?

Answer 1

Requirement (1) Computation of Break Even in units under both the existing and proposed situation : Break Even in Units = Fixed Cost / Contribution Margin Per Unit Particulars Selling price per Unit Less : Variable Cost per unit Less : Sales Commission per unit Contribution Margin per unit (1) Existing $ $ $ $ Proposed 200 $ (60) $ $ 140 $ 200 (60) (10) 130 Fixed Costs (0) 280,000 $ 247,000 (283000-33000) Break Even in units = (ii)/0) 2000 Units 1900 Units Proposed Requirement (2) Particulars Total Sales Revenue (7000 units *$ 200) (7200 units *$ 200 Existing $ 1,400,000 $ 1,440,000 Less : Break even sales (2000 units x $200) (1900 units x $200) $ (400,000) $ (380,000) Margin of safety sales $ 1,000,000 $1,060,000 Requirement (3) Particulars No of units (0) Contribution margin per unit (0) Total Contribution margin Less : Fixed costs Net Operating Income Existing Proposed 7000 7200 $ 140 $ 130 $ 980,000 $ 936,000 $ (280,000 $ (247,000) $ 700,000 $ 689,000 Requirement (4) Based on the above comparision, Existing situation is recommended because net operating income is higher compared to new proposal Note : Please comment down for any further clarifications