Diego Company manufactures one product that is sold for $70 per unit in two geog

Question

Diego Company manufactures one product that is sold for $70 per unit in two geographic regions—the East and West regions. The following information pertains to the company’s first year of operations in which it produced 53,000 units and sold 48,000 units.

  

  

The company sold 36,000 units in the East region and 12,000 units in the West region. It determined that $270,000 of its fixed selling and administrative expenses is traceable to the West region, $220,000 is traceable to the East region, and the remaining $67,000 is a common fixed cost. The company will continue to incur the total amount of its fixed manufacturing overhead costs as long as it continues to produce any amount of its only product. question below

Assume the West region invests $43,000 in a new advertising campaign in Year 2 that increases its unit sales by 20%. If all else remains constant, what would be the profit impact of pursuing the advertising campaign?

   

  Variable costs per unit:      Manufacturing:         Direct materials $ 21            Direct labor $ 10            Variable manufacturing overhead $ 2            Variable selling and administrative $ 4      Fixed costs per year:      Fixed manufacturing overhead $ 1,060,000         Fixed selling and administrative expenses $ 557,000   

Explanation / Answer

Step 1: Calculate Current Contribution Per Unit and Total Contribution for West Region

The current contribution per unit can be calculated with the use of following formula:

Contribution Per Unit = 70 (Selling Price) - 21 (Direct Material) - 10 (Direct Labor) - 2 (Variable Manufacturing Overhead) - 4 (Variable Selling Overhead) = $33 per unit

Total Contribution = Total Units Sold*Contribution Per Unit = 12,000*33 = $396,000

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Step 2: Calculate Impact On Net Income With Advertising Campaign

The impact of advertising campaign can be determined with the increase in contribution resulting from additional sales and fixed cost incurred towards advertising.

Additional Contribution = Current Contribution*Percentage Increase in Unit Sales = 396,000*20% = 79,200

Incremental Income = Additional Contribution - Advertising Costs = 79,200 - 43,000 = $36,200

The profit will increase by an amount of $36,200 as a result of pursing the advertising campaign.

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