Morton Company’s contribution format income statement for last month is given be

Question

Morton Company’s contribution format income statement for last month is given below: Sales (44,000 units × $29 per unit) $ 1,276,000 Variable expenses 893,200 Contribution margin 382,800 Fixed expenses 306,240 Net operating income $ 76,560 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 $8.70 per unit. However, fixed expenses would increase to a total of $689,040 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. (Round your "Per unit" answers to 2 decimal places.) 2. Refer to the income statements in (1) above. For both present operations and the proposed new operations, compute a. The degree of operating leverage. b. The break-even point in dollar sales. c. The margin of safety in both dollar and percentage terms. 3. Refer again to the data in (1) above. 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.) Reserves and surplus of the company Performance of peers in the indstry Cyclical movements in the economy Stock level maintained 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 50% without any change in selling price; the company’s new monthly fixed expenses would be $382,800, and its net operating income would increase by 25%. Compute the break-even point in dollar sales for the company under the new marketing strategy.

Explanation / Answer

Existing & New Equipment

Existing & New Marketing Strategy

Break Even Point new Marketing Strategy is $1531200

Existing New Equipment Particulars Per Unit Cost 44000 Units Per Unit Cost 44000 Units Sales 29 1276000 29 1276000 Less: Variable Expenses: 893200/44000; (20.3-8.70) 20.3 893200 11.6 510400 Contribution Margin: (Sales-Variable Cost) 8.7 382800 17.4 765600 Less: Fixed Expenses 306240 689040 Net Operating Income 76560 76560 Contribution Margin Ratio: (382800/1276000); (765600/1276000) 30% 60% Degree of Operating Leverage: Contribution Margin/ Net Operating Income: (382800/76560); (765600/76560) 5 10 Break Even Point (Sales): Fixed Cost/Contribution Margin Ratio: 306240/30% ; 689040/60% 1020800 1148400 Margin of Safety (%): (Sales-Break even Sales)/Sales : (1276000-1020800)/1276000; (1276000-1148400)/1276000 20% 10% Margin of Safety ($): Net Profit/Contribution Margin Ratio: (76560/30%); (76560/60%) 255200 127600

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