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RayLok Incorporated has invented a secret process to improve light intensity and, as a result, manufactures a variety of products related to this process. Each product is independent of the others and is treated as a separate profit/loss division. Product (division) managers have a great deal of freedom to manage their divisions as they think best. Failure to produce target divisional income is dealt with severely; however, rewards for exceeding one’s profit objective are, as one division manager described them, lavish.

The DimLok Division sells an add-on automotive accessory that automatically dims a vehicle’s headlights by sensing a certain intensity of light coming from a specific direction. DimLok has had a new manager in each of the 3 previous years because each manager failed to reach RayLok’s target profit level. Donna Barnes has just been promoted to manager and is studying ways to meet the current target profit for DimLok.

DimLok’s two profit targets for the coming year are $990,000 (20% return on the investment in the annual fixed costs of the division) and $20 (pre-tax) profit for each DimLok unit sold. Other constraints on the division’s operations are as follows:

• Production cannot exceed sales because RayLok’s corporate advertising program stresses completely new product models each year, although the models might have only cosmetic changes.
• DimLok’s selling price cannot vary above the current selling price of $250 per unit but may vary as much as 10% below $250.
• A division manager can elect to expand fixed production or selling facilities; however, the target profit objective related to fixed costs is increased by 20% of the cost of any such expansion. Furthermore, a manager cannot expand fixed facilities by more than 30% of existing fixed cost levels without approval from the board of directors.

Donna is now examining data gathered by her staff to determine whether DimLok can achieve its target profits of $990,000 and $20 per unit. A summary of these reports shows the following:

• Last year’s sales were 48,000 units at $250 per unit.
• DimLok’s current manufacturing facility capacity is 58,000 units per year, but can be increased to 116,000 units per year with an increase of $1,180,000 in annual fixed costs.
• Present variable costs amount to $150 per unit, but DimLok’s vendors are willing to offer direct materials discounts amounting to $30 per unit, beginning with unit number 78,001.
• Sales can be increased up to 136,000 units per year by committing large blocks of product to institutional buyers at a discounted unit price of $220. However, this discount applies only to sales in excess of 58,000 units per year.

Donna believes that these projections are reliable and is now trying to determine what DimLok must do to meet the profit objectives assigned by RayLok’s board of directors.

Required:

1. Determine the dollar amount of DimLok’s present annual fixed costs per year.

2. Determine the number of units that DimLok must sell to achieve both profit objectives. Be sure to consider all constraints in determining your answer.

3. Without regard to your answer in requirement 2, assume that Donna decides to sell 58,000 units at $250 per unit and 41,450 units at $220 per unit.

(a) Prepare a budgeted income statement (contribution format) for DimLok showing budgeted operating income.

(b) Would this projected operating income meet the stated profit objectives?

Answer 1

Answer with working is given below

Current Fixed cost Profit target at 20% on Fixed Cost $990,000 1. $4,950,000 Fixed costs is (Profit /20%) Selling price Variable cost Contribution per unit $250 $150 $100 2. Profit per bike Revised Contribution per bike $20 $80 Fixed cost and Profit needed $5,940,000 Number of bikes to be sold 74,250 (Fixed Cost+profit)/ Contribution per bike Since units is exceeding capacity of 58,000 units fixed cost will increase by $1,180,000 per year Revised Fixed cost $6,130,000 $1,226,000 $7,356,000 Profit at 20% on above Total Contribution per bike $80 Number of bikes to be sold - units 91,950 Cross checking Sales-91,950 units $22,987,500 $13,792,500 $9,195,000 Less: Variable cost Contribution $6,130,000 $3,065,000 Fixed Cost Net profit $1,226,000 20% on Fixed cost profit at $20 on bike sold $1,839,000 $3,065,000 Total Profit achieved Budgeted Income Statement Sales 3.a) $14,500,000 $9,119,000 58,000 250) (41,450*220) Total Sales $23,619,000 Less: Variable cost $11,700,000 $2,574,000 (78,000 150) (21,450 120) Total Variable cost $14,274,000 $9,345,000 Contribution Fixed Cost Net Profit $6,130,000 $3,215,000 3.b) Profit Objective is achieved Profit required ROI on Fixed Cost 20% Profit of $20 per bike sold Total Profit $1,226,000 $1,989,000 $3,215,000