Question

Morton Company’s contribution format income statement for last month is given below: Sales (49,000 units × $29 per unit) $ 1,421,000 Variable expenses 994,700 Contribution margin 426,300 Fixed expenses 341,040 Net operating income $ 85,260 The industry in which Morton Company operates is quite sensitive to cyclical movements in the economy. Thus, profits vary considerably from year to year according to general economic conditions. The company has a large amount of unused capacity and is studying ways of improving profits.

Required: 1. New equipment has come onto the market that would allow Morton Company to automate a portion of its operations. Variable expenses would be reduced by $8.70 per unit. However, fixed expenses would increase to a total of $767,340 each month. Prepare two contribution format income statements, one showing present operations and one showing how operations would appear if the new equipment is purchased. (Round your "Per unit" answers to 2 decimal places.)

2.Refer to the income statements in (1) above. For both present operations and the proposed new operations, compute a. The degree of operating leverage. b. The break-even point in dollar sales. c. The margin of safety in both dollar and percentage terms.

3. Refer again to the data in (1) above. As a manager, what factor would be paramount in your mind in deciding whether to purchase the new equipment? (Assume that enough funds are available to make the purchase.) Cyclical movements in the economy Performance of peers in the indstry Stock level maintained Reserves and surplus of the company

4. Refer to the original data. Rather than purchase new equipment, the marketing manager argues that the company’s marketing strategy should be changed. Rather than pay sales commissions, which are currently included in variable expenses, the company would pay salespersons fixed salaries and would invest heavily in advertising. The marketing manager claims this new approach would increase unit sales by 50% without any change in selling price; the company’s new monthly fixed expenses would be $426,300, and its net operating income would increase by 25%. Compute the break-even point in dollar sales for the company under the new marketing strategy.

Answer 1

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Part 1
			Current	New
Sales			$            1,421,000	$            1,421,000
Less: Variable Expense	49000*11.60		$              -994,700	$              -568,400
Contribution Margin			$                426,300	$                852,600
Less: Fixed Expense			$              -341,040	$              -767,340
Net Operating Income			$                  85,260	$                  85,260
Existing Variable Expense per unit	994700/49000	$    20.30
New Variable per unit	20.30-8.70	$    11.60
Part 2
			Current	New
a Degree of Operating Leavarage
Contribution Margin/Net Operating Income			426300/85260	852600/85260
			5.00	10.00
b. Break even point in dollar sales			341040/30%	767340/60%
Fixed Cost/CM Ratio			$            1,136,800	$            1,278,900
Contribution Margin Ratio	CM/Sales		30.00%	60.00%
c. Margin of Safety Dollars			1421000-1136800	1421000-1278900
Actual sales-Break even sales			$                284,200	$                142,100
c. Margin of Safety percentage
(Actual sales-Break even sales)/Actual Sale			20.00%	10.00%
Part 4
Sales	(49000*150%)*29		$            2,131,500
Net Income	85260*125%		$                106,575
Fixed Expense			$                426,300
Variable Expense			$            1,598,625
Sale-Net Income-Fixed Expense
Contribution Margin	2131500-1598625		$                532,875
CM Ratio	532875/2131500		25.00%
Break Even Point Sales Dollars	426300/25%		$            1,705,200
Fixed Expense/CM Ratio