Broadening Your Perspective 6-2 (Part Level Submission) For nearly 20 years, Spe

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Broadening Your Perspective 6-2 (Part Level Submission) For nearly 20 years, Specialized Coatings has provided painting and galvanizing services for manufacturers in its region. Manufacturers of various metal products have relied on the quality and quick turnaround time provided by Specialized Coatings and its 20 skilled employees. During the last year, as a result of a sharp upturn in the economy, the company's sales have increased by 30% relative to the previous year. The company has not been able to increase its capacity fast enough, so Specialized Coatings has had to turn work away because it cannot keep up with customer requests Top management is considering the purchase of a sophisticated robotic painting booth. The booth would represent a considerable move in the direction of automation versus manual labor. If Specialized Coatings purchases the booth, it would most likely lay off 15 of its skilled painters. To analyze the decision, the company compiled production information from the most recent year and then prepared a parallel compilation assuming that the company would purchase the new equipment and lay off the workers. Those data are shown below As you can see, the company projects that during the last year it would have been far more profitable if it had used the automated approach Current Approach Approach Automated Sales Variable costs Contribution margin Fixed costs Net income $1,920,000 $1,920,000 960,000 960,000 768,000 $192,000 1,440,000 480,000 365,000 $115,000 ? (a1) Your answer is correct. Compute the contribution margin ratio under each approach. (Round ratios to 0 decimal places, e.g. 15%.) Current approach Automated approach Contribution margin ratio 25 S0

Explanation / Answer

d). Degree of Operating leverage = Contribution /EBIT
Current Approach: 480000/115000 = 4.17
Atomated Approach : 960000/192000 = 5

If Net Sales reduce by 10%, contribution also decreases by 10%, then the change in net income in % is :
Current Approach: New Contribution = 480000-10% = 432000
                           Net Income : 432000-365000 = 67000
                           % change in net income = (115000-67000)/115000 = 48000/115000 = 41.73%

Atomated Approach : New Contribution = 960000-10% = 864000
                                Net Income = 864000-768000 = 96000
                                % change in net income = (192000-96000)/192000 = 50%

e). Let the sales value be x:
The equation would be
0.25x-365000 = 0.5x-768000
0.25x = 403000    then x=1612000 i.e the value of sales

f). While making the decision, it is shown beneficial as per the Income statement but the company should also consider the qualitative and other intagible factors which may have a significant impact on the company.

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