Question

In: Accounting

Magic Inc. sells a single product at a selling price of $57 per unit. Magic’s variable...

Magic Inc. sells a single product at a selling price of $57 per unit. Magic’s variable costs are $35 per unit and its total fixed costs are $719,400 per year. Magic is considering the purchase of new equipment which would reduce its variable costs to $28 per unit but increase its total fixed costs to

$1,023,700 per year.

a. Assuming Magic expects to sell 40,000 units per year, should it purchase the new equipment?

b. Would your answer change if Magic expects to sell 50,000 units per year?

Expert Solution

a.

Assuming Magic expects to sell 40,000 units per year

Increase(Decrease) in net operating income = Increase in total comtribution - increase in total fixed cost

= $ 2,80,000 - $ 3,04,300

= ( $ 24,300 )

Magic Inc should not purchase new equipment as it is resulting in decrease in net operating income by $ 24,300

Working Note:

Increase in total comtribution = Total revised contribution - Total Contribution at current

= $ 11,60,000 - $ 8,80,000

= $ 2,80,000

Increase in total fixed cost = Total revised fixed cost - Total current fixed cost

= $ 10,23,700 - $ 7,19,400

= $ 3,04,300

Total Contribution at current= Contribution per unit * expected number of units sold

= ($57-$35) * 40,000

= $22 * 40,000

= $ 8,80,000

Total revised contribution = Revised Contribution per unit * expected number of units sold

= ( $57- $28) * 40,000

= $29 * 40,000

= $ 11,60,000

b.

Assuming Magic expects to sell 50,000 units per year

Increase(Decrease) in net operating income = Increase in total comtribution - increase in total fixed cost

= $ 3,50,000 - $ 3,04,300

= $ 45,700

Magic Inc should purchase new equipment as it is resulting in increase in net operating income by $ 45,700

Working Note:

Increase in total comtribution = Total revised contribution - Total Contribution at current

= $ 14,50,000 - $ 11,00,000

= $ 3,50,000

Increase in total fixed cost = Total revised fixed cost - Total current fixed cost

= $ 10,23,700 - $ 7,19,400

= $ 3,04,300

Total Contribution at current= Contribution per unit * expected number of units sold

= ($57-$35) * 50,000

= $22 * 50,000

= $ 11,00,000

Total revised contribution = Revised Contribution per unit * expected number of units sold

= ( $57- $28) * 50,000

= $29 * 50,000

= $ 14,50,000

ekkarill92 answered 2 years ago

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