Question

Diego Company manufactures one product that is sold for $70 per unit in two geographic regions—the East and West regions. The following information pertains to the company’s first year of operations in which it produced 53,000 units and sold 48,000 units.

Variable costs per unit:

Manufacturing:

Direct materials $ 21

Direct labor $ 10

Variable manufacturing overhead $ 2

Variable selling and administrative $ 4

Fixed costs per year:

Fixed manufacturing overhead $ 1,060,000

Fixed selling and administrative expense $ 557,000

The company sold 36,000 units in the East region and 12,000 units in the West region. It determined that $270,000 of its fixed selling and administrative expense is traceable to the West region, $220,000 is traceable to the East region, and the remaining $67,000 is a common fixed expense. The company will continue to incur the total amount of its fixed manufacturing overhead costs as long as it continues to produce any amount of its only product. 15. Assume the West region invests $43,000 in a new advertising campaign in Year 2 that increases its unit sales by 20%.

If all else remains constant, what would be the profit impact of pursuing the advertising campaign?

Answer 1

Answer

Existing Condition

Unit Cost
Direct Material	21
Direct Labor	10
Variable Manufacturing Overhead	2
Fixed Manufacturing per unit	20
Per unit Cost	53
Income Statement
	Total
		East	West
Sales (No. of units sold * $70 per unit)	3,360,000	2,520,000	840,000
Less: Cost of Goods Sold (No. of Units sold * $53 per unit)	2,544,000	1,908,000	636,000
Gross Profit	816,000	612,000	204,000
Less: Selling and Administrative Cost	-
Variable Selling and Adm. Expenses (No. of Units sold * $4 per unit)	192,000	144,000	48,000
Fixed Selling and Adm. Expenses	-
Traceable	490,000	220,000	270,000
Untraceable	67,000
Net Operating Income	67,000	248,000	(114,000)

Proposed

New Units of West = 14,400 Units (12,000 Units + 20%)

Income Statement
	Total
		East	West
Sales (No. of units sold * $70 per unit)	3,528,000	2,520,000	1,008,000
Less: Cost of Goods Sold (No. of Units sold * $53 per unit)	2,544,000	1,908,000	636,000
Gross Profit	984,000	612,000	372,000
Less: Selling and Administrative Cost
Variable Selling and Adm. Expenses (No. of Units sold * $4 per unit)	192,000	144,000	48,000
Fixed Selling and Adm. Expenses
Traceable	490,000	220,000	270,000
Untraceable	67,000	-	-
Advertisement Expenses	43,000	-	43,000
Net Operating Income	192,000	248,000	11,000

West region which was previously incurring loss, After advertisement campaign it is earning profit of $11,000 and Total Profit of the company has also increased by $125,000 (192,000 – 67,000).

The decision is financially viable.