3-11 CVP analysis (LO 3) Carr Orthotics Company distributes a specialized ankle
ID: 2337568 • Letter: 3
Question
3-11 CVP analysis (LO 3)
Carr Orthotics Company distributes a specialized ankle support that sells for $30. The company’s variable costs are $18 per unit; fixed costs total $360,000 per year.
Required
a. If sales increase by $39,000 per year, by how much should operating income increase?
b. Last year, Carr sold 32,000 ankle supports. The company’s marketing manager is convinced that a 10% reduction in the sales price, combined with a $50,000 increase in advertising, will result in a 25% increase in sales volume over last year. Should Carr implement the price reduction? Why or why not?
Explanation / Answer
(a) – Increase in Operating Income
Contribution per unit = Selling price per unit – variable cost per unit
= $30 – 18
= $12 per unit
Contribution Margin Ratio = [Contribution per unit / Selling price per unit] x 100
= [$12 / $30] x 100
= 0.40 or
= 40%
If the sale is increased by $39,000, then the Operating Income will increase by $15,600 [$39,000 x 40%]. The fixed costs shall not be considered here, since the fixed costs will not change in case of increase or decrease in the sales volume.
(b) – Implementation of Price Reduction
Net Operating Income before implementing the price reduction
Net Operating Income = Sales – variable costs – Fixed costs
= [32,000 units x $30] – [32,000 units x $18] - $360,000
= $960,000 – 576,000 – 360,000
= $24,000
Net Operating Income after implementing the price reduction
Net Operating Income = Sales – variable costs – Fixed costs
= [(32,000 units x 125%) x ($30 x 90%)] – [(32,000 units x 125%) x ($18 x 90%)] – [$360,000 + 50,000]
= $10,80,000 - 648,000 – 410,000
= $22,000
DECISION
NO. Carr Orthotics Company should not implement the price reduction, since there will be a reduction in their net operating income of $2,000 ($24,000 – 22,000) if the company implements the price reduction policy.
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