The owners of Katy EH Manufacturing, a small manufacturer of gas grills, have pr
ID: 2464150 • Letter: T
Question
The owners of Katy EH Manufacturing, a small manufacturer of gas grills, have prepared a preliminary budget for the upcoming year and would like to assess the financial impact of several alternative scenarios, including dropping a product; changing the price on a product, with a resulting increase in volume; and shifting advertising focus, with a resulting shift in volume from one product to another. A new budget must be prepared. At year-end, the actual results are better than had been planned, but not necessarily better than what should have been, given actual sales volumes.
Hint Consider using the topic of contribution analysis as an easy way to analyze profit-planning issues such as adding or dropping a product or service; changing a price; adding or decreasing expected volumes; or preparing a profit budget. In this particular situation, there are three products, each with different proportions of variable and fixed costs. Make sure you can identify variable and fix costs. Pay attention to the relation of profit and contribution margin. In addition, you also need to consider non-financial factors prior to make your decision.
Required :
a) Should Katy EH drop Grill A? The owners wanted to know the impact of dropping Grill A from their line of products. Sharp was told to assume that the volumes and selling prices of the other two products would be the same whether or not the Grill A product line was dropped.
b) Should Katy EH lower the price of Grill C? The owners wanted to know the impact if they lowered the price of Grill C to $75 and if doing so led to a 20,000-unit increase in sales of Grill C .
c) Should Katy EH change its advertising focus? The owners wanted to know the impact of a 10,000-unit increase in Grill C volume and a related 10,000-unit decrease in Grill A volume because of a shift in advertising emphasis.
d) Should Katy EH lower the price of Grill C and change its advertising focus? The owners wanted to know the impact of lowering the price of Grill C to $75 and shifting the advertising focus more to Grill C, thereby decreasing Grill A volume by 10,000 units and increasing Grill C volume by 30,000 units .
e) Prepare a revised 2016 profit budget assuming the owners chose Option 2 – lowering the price of Grill C to $75 and expecting sales volume of that grill to increase to 220,000 units.
f) The actual results for 2016 are shown in Exhibits3-4. Was 2016 net income more or less than what should have been expected given these actual volumes and prices? If the results were different, why .
Exhibit 1: Operating Budget 2016: Draft 12/18/2015
Exhibit 2: Operating Budget 2016: Draft 12/18/2008
*This category comprises accounting, IT, human resources, legal, and others supporting the production of these products.
Exhibit 3: Actual 2016 Volume & Price
Exhibit 4: 2016 Operating Results: Draft 1/19/2017
Sales $41,200,000 Less: cost of products sold 22,800,000 Gross margin $18,400,000 SG&A 9,350,000 Other costs 2,100,000 Operating income $6,950,000 Less: Interest expense 420,000 Plus: Interest income 150,000 Income before tax $6,680,000 Income taxes 2,338,000 Net income $4,342,000Explanation / Answer
Note :
1. If you increase or decrease the price of a product, all other costs remeining constant, the contribution goes up or down.
2. In a firm, even though the allocation fixed costs is done to arrive at the contribution or profitablity of a project(s), it is on an arbitrary basis.
3. Fixed costs, once incurred, cannot be decreased on a short-term basis.
4. In option(a) if product Grill A was to be dropped, the sales and prices of other products remaining constant, it would have resulted in a loss of $94 contribution per unit of A and the loss would go up by that extent of the product sold.
5. In option (b),If the sale price of Product C is reduced to $75 i.e. by $5, this would result in a contribution of $*220,000(budgeted) = $1,100,000 being lost
6.In option(c), this results in a loss of operating income of $1,825000 since Product A give a greater contribution than Product C.
7.Option (d) results in a loss of operating income of $1,955,000 since the contribution of Product A is more than that of Product C.and there fore, decreasing the volume of sales of Product A and increasing the sales of Product C by decreasing its price, results in a greater loss of operating income.
Actual income is more given that there is an increase in actual sales of Product a and Product B which give greater contribution per unit than Product C even though its price has been reduced and sales have increased.
Second, reason is that fixed costs remaining constant, if sales have gone up then this results in reduction in fixed cost per unit. This also has the effect of increasing the net income.
contribution from Products Product Grill A Grill B Grill C Sales price 150 110 80 Variable costs a) Product Grill A should not be dropped as it has a contribution of $94 towards the Materials 17 10 7 overall income of the firm - moreover as dropping it does not result in increase in sales Labor 21 16 4 of the other products Indirect materials 7 2 1 Indirect labor 5 4 2 energy 6 3 2 Variable costs 56 35 16 contribution 94 75 64 fixed costs : labor 5 4 2 supervision 8 3 1 energy 6 3 2 depreciation 22 7 5 support 12 6 2 all others 11 2 1 total fixed costs 64 25 13 Profitability 30 50 51 Option B increase in sales of grill C by 20000 units Product Grill A Grill B Grill C units 80000 120000 220000 sale price 150 110 75 Less : Variable costs 56 35 16 contribution 94 75 59 Fixed costs 64 25 13 Profit per unit 30 50 46 Total profit 2400000 6000000 10120000 18520000 If the price of Grill C is decreased by $5 per unit the gross margin goes down by (20635000-18520000=2115000. Option C increase in sales of grill C by 10000 units and decrease in Grill C by 10000 units Product Grill A Grill B Grill C units 70000 120000 210000 sale price 150 110 80 Less : Variable costs 56 35 16 contribution 94 75 64 Fixed costs 64 25 13 Profit per unit 30 50 51 Total profit 2100000 6000000 10710000 18810000 The shift in advertising focus results in a decrease of gross margin by (20635000-18810000)=1,825,000 Option D changing of advertising focus and lowering the price of Grill C Product Grill A Grill B Grill C units 70000 120000 230000 sale price 150 110 75 Less : Variable costs 56 35 16 contribution 94 75 59 Fixed costs 64 25 13 Profit per unit 30 50 46 Total profit 2100000 6000000 10580000 18680000 Decrease in Gross Margin by (20635000-18680000)=1955000 Option E Revised Profit Budget Product Grill A Grill B Grill C units 80000 120000 220000 sale price 150 110 75 Less : Variable costs 56 35 16 contribution 94 75 59 Fixed costs 64 25 13 Profit per unit 30 50 46 Total profit 2400000 6000000 10120000 18520000 Less : SG & A 9350000 Other costs 2100000 Operating income 7070000 Less : interest expense 420000 Plus : interest income 150000 Income before tax 6800000 Income taxes 2380000 Net income 4420000Related Questions
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