Waterways is thinking of mass-producing one of its special-order sprinklers. To

Question

Waterways is thinking of mass-producing one of its special-order sprinklers. To do so would increase variable costs for all sprinklers by an average of $0.70 per unit. The company also estimates that this change could increase the overall number of sprinklers sold by 10%, and the average sales price would increase $0.20 per unit. Waterways currently sells 491,740 sprinkler units at an average selling price of $26.50. The manufacturing costs are $6,863,512 variable and $2,050,140 fixed. Selling and administrative costs are $2,651,657 variable and $794,950 fixed. If Waterways begins mass-producing its special-order sprinklers, how would this affect the company?

Explanation / Answer

Contribution Margin Ratio = Contribution per unit / Selling price per unit

Working notes.

Current Situation:

Variable cost per unit

= total variable cost / number of units sold

= ($6863512 + $2651657) / 491740 = $19.35 per unit

Contribution per unit = Selling price per unit - variable cost per unit = $ 26.50 - $19.35 = $7.15

Contribution Margin ratio = $7.15 / $26.50 = 27%

Net Income

= Total Contribution - Total fixed cost

= 491740 units x $7.15/unit - ($2050140 + $794950)

= $670851

Present Situation

Revised Variable cost = $19.35 + $0.70 = $20.05

Revised selling price per unit = $26.50 + $0.20 = $26.70

Revised contribution per unit = $26.70 - $20.05 = $6.65

Revised contribution margin ratio = $6.65 / $26.70 = 25%

Revised Net Income

= 491740 x 110% x $6.65 - ($2050140 + $794950)

= $751988.10

Current New Effect Contribution margin ratio 27% 25% Decreases by 2% Net Income $670851 $751988 Increases by $81137.10

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