Question

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 $1,000,000 (20% return on the investment in the annual fixed costs of the division) and $40 (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 $320 per unit but may vary as much as 5% below $320. 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 $1,000,000 and $40 per unit. A summary of these reports shows the following: Last year's sales were 50,000 units at $320 per unit. DimLok's current manufacturing facility capacity is 60,000 units per year, but can be increased to 120,000 units per year with an increase of $1,200,000 in annual fixed costs. Present variable costs amount to $200 per unit, but DimLok's vendors are willing to offer direct materials discounts amounting to $20 per unit, beginning with unit number 80,001. Sales can be increased up to 140,000 units per year by committing large blocks of product to institutional buyers at a discounted unit price of $300. However, this discount applies only to sales in excess of 60,000 units per year.

Answer 1

Answer is given below with all working

Current Fixed cost Profit target at 20% on Fixed Cost $1,000,000 $5,000,000 Fixed costs is (Profit/20%) Selling price Variable cost Contribution per unit $320 $200 $120 Profit per vehicle Revised Contribution per bike $40 $80 Fixed cost and Profit needed $6,000,000 75,000 Number of bikes to be sold (Fixed Cost+profit)/ Contribution per bike Since units is exceeding capacity of 60,000 units fixed cost will increase by 20% Revised Fixed cost Existing Fixed Cost Increase in Fixed cost Revised Fixed cost Profit at 20% on above Total Target needed $5,000,000 $1,200,000 $6,200,000 $1,240,000 $7,440,000 Considering all constraints First 60,000 Units $320 60,000 -80,000 units $300 In excess of 80,000 units $300 $180 $120 Selling price Variable cost Contribution per unit $200 $200 $100 $120 $40 Profit per bike Revised Contribution per bike Units Total Contribution $40 $80 60,000 $4,800,000 $40 $60 20,000 $1,200,000 Balance Contribution (A-B-C) Units to achieve above contribution $1,440,000 18,000 First Slab Second Slab Third Slab Total Units to achieve profit objective 60,000 20,000 18,000 98,000 3.a) $30,600,000 Budgeted Income Statement Revenue (60,000 *320) $19,200,000 (38,000*300) $11,400,000 Total Revenue Less: Variable cost (80,000 *200) $16,000,000 (18,000*180) $3,240,000 Total Variable cost Contribution Margin Fixed Cost Operating Income $19,240,000 $11,360,000 $6,200,000 $5,160,000 Profit Objective 20% on Fixed cost Profit of $40 per bike sold Total Profit $1,240,000 $3,920,000 $5,160,000 3.b) Based on above working profit objective has been achieved