Question

Ohio Limestone Company produces thin limestone sheets used for cosmetic facing on buildings. The following income statement represents the operating results for the year just ended. The company had sales of 1,800 tons during the year. The manufacturing capacity of the firm’s facilities is 3,000 tons per year. (Ignore income taxes.)

OHIO LIMESTONE COMPANY
Income Statement
For the Year Ended December 31, 20x1
Sales	$	900,000
Variable costs:
Manufacturing	$	315,000
Selling costs		180,000
Total variable costs	$	495,000
Contribution margin	$	405,000
Fixed costs:
Manufacturing	$	100,000
Selling		107,500
Administrative		40,000
Total fixed costs	$	247,500
Net income	$	157,500

Required:

1. Calculate the company’s break-even volume in tons for 20x1.

2. If the sales volume is estimated to be 2,100 tons in the next year, and if the prices and costs stay at the same levels and amounts, what is the net income that management can expect for 20x2?

3. Ohio Limestone has been trying for years to get a foothold in the European market. The company has a potential German customer that has offered to buy 1,500 tons at $450 per ton. Assume that all of the firm’s costs would be at the same levels and rates as in 20x1. What net income would the firm earn if it took this order and rejected some business from regular customers so as not to exceed capacity?

4. Ohio Limestone plans to market its product in a new territory. Management estimates that an advertising and promotion program costing $61,500 annually would be needed for the next two or three years. In addition, a $25 per ton sales commission to the sales force in the new territory, over and above the current commission, would be required. How many tons would have to be sold in the new territory to maintain the firm’s current net income? Assume that sales and costs will continue as in 20x1 in the firm’s established territories. (Round your answer to 1 decimal place.)

5. Management is considering replacing its labor-intensive process with an automated production system. This would result in an increase of $58,500 annually in fixed manufacturing costs. The variable manufacturing costs would decrease by $25 per ton. Compute the new break-even volume in tons and in sales dollars.

6. Ignore the facts presented in requirement (5). Assume that management estimates that the selling price per ton would decline by 10 percent next year. Variable costs would increase by $40 per ton, and fixed costs would not change. What sales volume in dollars would be required to earn a net income of $94,500 next year? (Do not round intermediate calculations.)

Answer 1

1.Calculation of company’s breakeven volume in tons for 20X1

According to information given in the question,

Sales = $ 9,00,000

Total fixed cost = $ 2,47,500

Total variable cost = $ 4,95,000

Contribution margin = $ 4,05,000

No of units sold = 1800 tons

According to formula,

Breakeven point in units = Total fixed cost/ Contribution margin per unit

Contribution margin per unit is given by dividing Contribution margin by number of units sold,

= $4,05,000/ 1800 = $ 225

Total fixed cost = $2,47,500

Hence, Breakeven point in units = (2,47,500/225) = 1100 units

2.Calculation of net income that management can expect for 20X2

		Amount	At 1800 units (per unit)		At 2100 units Amount	Remarks
Sales	$	900000	$500	$	1050000	500*2100
Variable costs:
Manufacturing	$	315000	$175	$	367500	175*2100
Selling costs	$	180000	$100	$	210000	100*2100
Total variable costs	$	495000	$275	$	577500	275*2100
Contribution margin	$	405000	$225	$	472500	225*2100
Fixed costs:
Manufacturing	$	100000		$	100000	Remains unchanged as it is under the maximum capacity
Selling	$	107500		$	107500	Remains unchanged as it is under the maximum capacity
Administrative	$	40000		$	40000	Remains unchanged as it is under the maximum capacity
Total fixed costs		247500			247500	Remains unchanged as it is under the maximum capacity
Net income	$	157500	$87.5	$	225000	At 2100 units income

3. Calculation of net income the firm would earn with the additional orders and rejection of orders from regular customers so as to not exceed the capacity

According the question,

Additional orders from European market = 1500 units

The firms manufacturing capacity is 3000 tons per year, Hence the fixed cost will not change till the manufacturing reaches 3000 tons.

It is also mentioned the additional orders will be fulfilled from existing capacity, hence the fixed cost will not change with additional orders.

Further it is mentioned that the firms costs would be at the same levels and rates as in 20X1

The firms existing free capacity = 3000 tons – 1800 tons = 1200 tons

Hence the firm needs to reject orders of (1500-1200) tons = 300 tons to accommodate the additional orders without increasing the capacity

Existing contribution margin per unit = $225

Hence contribution from existing orders will be $225 * 1500 = $337500

Contribution from additional 1500 tons sold at $450 per unit = $(450 – 275)*1500 = $262500

Total contribution earned = $(337500 + 262500) = $600000

Total fixed cost as given in the question - $247500

Hence Net income = $352500

4. Calculation of number of tons required to be sold in the new territory

Reduction in contribution per unit due to increase in selling commission per unit = $ 25

Existing contribution per unit = $ 225

Contribution from new territory = $(225-25) = $200

Increase in annual cost on advertisement and promotion = $61500

Since this is an annual cost and is not dependent on the number of units sold, it is in the nature of fixed cost and will incur even if one additional unit is sold

Existing net income = $157500

To achieve the same level of net income after incorporating increase in the fixed cost and variable cost additional units required to be sold will be given by

Additional cost to be recovered/ contribution per unit

= $61500/ $200 = 307.5 or 308 (rounded off to one decimal place)