Question

Due to the sluggish economy, the Constellation Company has experienced some difficulty in selling its deluxe microwave ovens.

The following data relate to the current year:

Sales (9,000 units @ $100/unit) $ 900,000

Less variable costs (9,000 @ $60/unit) 540,000 Contribution margin $ 360,000 Less fixed costs 400,000 Net operating loss $ (40,000 )

Required:

1. Compute Constellation's annual breakeven point, in both units and dollars. Also, compute the contribution margin ratio.

2. The manager believes that a $40,000 increase in advertising would result in a $120,000 increase in annual sales. If the manager is right, what will be the net effect on the company's operating income?

3. Refer to the original data. The vice-president in charge of sales is certain that a 10% reduction in selling price in combination with a $30,000 increase in advertising will cause sales volume to increases by 50%. What effect would this strategy have on operating income of the company?

4. Refer to the original data. In the following year, Constellation saved $5 of total variable costs per oven by buying parts from a different manufacturer. However, Constellation's rent and insurance increased by $5,600. The store sold 11,000 bikes. What was its operating income for the year?

Answer 1

Solution 1:

Contribution margin per unit = Selling price per unit - Variable cost per unit = $100 - $60 = $40 per unit

Contribution margin ratio = CM per unit / Selling price per unit = $40 / $100 = 40%

Breakeven point = Fixed costs / Contribution margin per unit = $400,000 /$40 = 10000 units

Solution 2:

Increase in operating income = Increase in contribution margin - Additional fixed costs

= ($120,000 * 40%) - $40,000 = $8,000

Net operating income will increase by $8,000

Solution 3:

New selling price = $100 * 90% = $90

New contribution margin per unit = $90 - $60 = $30 per unit

New fixed costs = $400,000 + $30,000 = $430,000

New sales volume = 9000*150% = 13500 units

New operating income = contribution margin - fixed costs = (13500 * $30) - $430,000 = (25,000)

Therefore net operating income will increase by $15,000 from previous year.

Solution 4:

New variable cost per unit = $60 - $5 = $55

Contribution margin per unit = $100 - $55 = $45 per unit

New fixed costs = $400,000 + $5,600 = $405,600

Sales volume = 11000 units

Operating income for the year = Contribution margin - fixed costs

= (11000*$45) - $405,600 = $89,400