Morton Company\'s contribution format income statement for last month is given b

Question

Morton Company's contribution format income statement for last month is given below Sales (44,000 units x $22 per unit) Variable expenses Contribution margin Fixed expenses Net operating income $ 968,000 677,600 290,400 232,328 $58,080 The industry in which Morton Company operates is quite sensitive to cyclical movements in the economy. Thus, profits vary considerably from year to year according to general economic conditions. The company has a large amount of unused capacity and is studying ways of improving profits Required: 1. New equipment has come onto the market that would allow Morton Company to automate a portion of its operations. Variable expenses would be reduced by $6.60 per unit. However, fixed expenses would increase to a total of $522,720 each month. Prepare two contribution format income statements, one showing present operations and one showing how operations would appear if the new equipment is purchased 2. Refer to the income statements in (1). For the present operations and the proposed new operations, compute (a) the degree of operating leverage, (b) the break-even point in dollar sales, and (c) the margin of safety in dollars and the margin of safety percentage 3. Refer again to the data in (1). As a manager, what factor would be paramount in your mind in deciding whether to purchase the new equipment? (Assume that enough funds are available to make the purchase.) 4. Refer to the original data. Rather than purchase new equipment, the marketing manager argues that the company's marketing strategy should be changed. Rather than pay sales commissions, which are currently included in variable expenses, the company would pay salespersons fixed salaries and would invest heavily in advertising. The marketing manager claims this new approach would increase unit sales by 30% without any change in selling price; the company's new monthly fixed expenses would be $244,904; and its net operating income would increase by 20%. Compute the company's break-even point in dollar sales under the new marketing strategy

Explanation / Answer

ANS   

1) MORTON COMPANY

CONTRIBUTION INCOME STATEMENT

PRESENT PROPOSED

AMOUNT PER UNIT % AMOUNT PER UNIT %

SALES $968000 $22 100% $968000 $22 100%

VARIABLE EXPENSES $677600 $15.4 70% $387200 $8.8 40%

CONTRIBUTION MARGIN $290400 $6.6 30% $580800 $13.2 60%

FIXED EXPENSES $232320 $522720

NET OPERATING INCOME $58080 $58080

2) PRESENT PROPOSED

DEGREE OF OPERATING LEVERAGE 5% 10% (CONTRIBUTION / NET INCOME)

BREAK EVEN POINT IN DOLLAR SALES $774400 $871200 (FIXED EXPENSES / CONTRIBUTION)*SALES

MARGIN OF SAFETY IN DOLLARS $193600 $96800

MARGIN OF SAFETY IN % 20% 10%

3) CYCLICAL MOVEMENTS IN THE ECONOMY

4) NEW SALES = 44000 UNITS + 44000 UNITS * 30% = 57200 UNITS * $22 = $1258400

NET OPERATING INCOME = $58080 + $58080 * 20% = $69696

FIXED EXPENSES = $244904

CONTRIBUTION = $244904 + $69696 = $314600

NEW BREAK EVEN POINT IN DOLLAR SALES = ($244904 / $314600) * $1258400

= $979616

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