Waterways Vice President for Sales and Marketing Sam Totter is trying to plan fo

Question

Waterways

Vice President for Sales and Marketing Sam Totter is trying to plan for the coming year in terms of production needs to meet the sales demand. He is also trying to determine ways in which the company’s profits might be increased in the coming year.

(a) Waterways markets a simple water control and timer that it mass-produces. During 2016, the company sold 696,000 units at an average selling price of per solution $4.20 per unit. The variable expenses were $1,900,080, and the fixed expenses were $683,256.

(1)What is the product’s contribution margin ratio? (Round to nearest whole percentage)

(2) What is the company’s break-even point in units and in dollars for this product?

(3) What is the margin of safety, both in dollars and as a ratio? (Round to nearest whole percentage)

(4) If management wanted to increase its income from this product by 10%, how many additional units would have to be sold to reach this income level?

(5) If sales increase by 51,000 units and the cost behaviors do not change, how much will income increase on this product?

(b) 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.

(1) If Waterways begins mass-producing its special-order sprinklers, how would this affect the company?

(2) If the average sales price per sprinkler unit did not increase when the company began mass-producing the special-order sprinkler, what would be the effect on the company?

Explanation / Answer

PART A

1. product’s contribution margin ratio = ((696000*4.20)-1900080)/(696000*4.20) = 35%

2.company’s break-even point in units and in dollars for this product:

break-even point in dollars = 683256/0.35 = $1952160

break-even point in units = 1952160/4.20 = 464800 units

3.margin of safety, both in dollars and as a ratio

margin of safety in dollars = (696000*4.20)-1952160 = 971040

margin of safety as a ratio = 971040/(696000*4.20) = 33%

4. If management wanted to increase its income from this product by 10%, how many additional units would have to be sold to reach this income level?

present income = ((696000*4.20)*0.35)-683256 = 339864

targeted income =339864*1.1 = 373850

sales = (373850+683256)/0.35 = 3020303

sales in units =3020300/4.20 = 719119

additional units = 719119-696000 = 23119

(5) If sales increase by 51,000 units and the cost behaviors do not change, how much will income increase on this product?

additional net income = 51000*4.20*0.35 = 74970 units

PART B

(1) If Waterways begins mass-producing its special-order sprinklers, how would this affect the company?

Increase in revenues

491740 x 0.20 =          98348

49174 x 26.75 =          1315405

Total                 =          1413753

Less additional

Cost

540914 x 0.70 =          378640

Variable mfg.    =          686351 (6863512/491740 x 49174)

Variable selling =          265166 (2651657 x 0.1)

Net change in profit = 83596

(2) If the average sales price per sprinkler unit did not increase when the company began mass-producing the special-order sprinkler, what would be the effect on the company?

Profit from above                   83596

Less affect of selling price

540914 x 0.20 -108183

Net decrease in profit           -24587

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