Question

For nearly 20 years, Specialized Coatings has provided painting and galvanizing services for manufacturers in its region. Manufacturers of various metal products have relied on the quality and quick turnaround time provided by Specialized Coatings and its 20 skilled employees ty During the last year, as a result of a sharp upturn in the economy, the company's sales have increased by 30% relative to the previous year. The company has not been able to increase its capacity fast enough, so Specialized Coatings has had to turn work away because it cannot keep up with customer requests. Top management is considering the purchase of a sophisticated robotic painting booth. The booth would represent a considerable move in the direction of automation versus manual labor. If Specialized Coatings purchases the booth, it would most likely lay off 15 of its skilled painters.

Answer 1

The answers are given below:

a. Contribution margin ratio: Contribution Margin / Sales x 100

Current Approach: $ 560,000 / $ 2,240,000 x 100 = 25%

Automated Approach: $ 1,120,000 / $ 2,240,000 x 100 = 50%

b. Break-even sales dollars: Fixed Costs / Contribution Margin Ratio

Current Approach: $ 426,000 / 25% = $ 1,704000

Automated Approach : $ 896,000 / 50% = $ 1,792000

c. Margin of safety ratio : ( Actual Sales - Break-even sales) / Actual Sales x 100

Current Approach : $ ( 2,240,000 - 1,704,000) / 2,240,000 x 100 = 24%

Automated Approach : $ ( 2,240,000 - 1,792,000) / 2,240,000 x 100 = 20%

d. Degree of operating leverage: Contribution Margin / Net Income

Current Approach: $ 560,000 / $ 134,000 = 4.17

Automated Approach: $ 896,000 / $ 224,000 = 4

If there is a 10% decline in sales, decline in net income for

Current Approach : 10% x 4.17 = 41.7%

Automated Approach : 10% x 4 = 40%

e. Let the level of sales be S.

Net Income = S x Contribution Margin Ratio - Fixed Cost

0.25 S - 426,000 = 0.5 S - 896,000

S = $ 1,880,000

At a sales level of $ 1,880,000, the net income will be $ 44,000 under either approach.