Question

Frieden Company's contribution format income statement for last month is shown below:

Sales (30,000 units)	$	1,200,000
Variable expenses		720,000
Contribution margin		480,000
Fixed expenses		384,000
Operating income	$	96,000

Competition is intense, and Frieden Company’s profits vary considerably from one year to the next. Management is exploring opportunities to increase profitability.

Required:

1. Frieden’s management is considering a major upgrade to the manufacturing equipment, which would result in fixed expenses increasing by $480,000 per month. However, variable expenses would decrease by $16 per unit. Selling price would not change. Prepare two contribution format income statements, one showing current operations and one showing how operations would appear if the upgrade is completed. Show an Amount column, a Per Unit column, and a Percentage column on each statement.

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

3-a. Calculate the unit sales per month at which Frieden management will be indifferent between doing the major upgrade to the manufacturing equipment and not doing the upgrade.

3-b. Based on the above analysis, should Frieden proceed with the major upgrade?

• Yes

• No

3-c. Why or why not?

4-a. Refer to the original data. Instead of doing the major upgrade to the equipment, management is considering introducing a new advertising campaign that will increase fixed expenses by $36,000 per month. Management believes the new advertisements will increase monthly unit sales by 10%. In this case what would be imapact on operating income.

4-b. Should Frieden proceed with the new advertising campaign?

• Yes

• No

Answer 1

Part 1
	Frieden Company
	Contribution Income Statement
		Present			Proposed
		Amount	Per unit	Percent	Amount	Per unit	Percent
	Sales	$                  1,200,000	$                          40.00	100.00%	$      1,200,000	$                21.00	100.00%
	Variable Costs	$                     720,000	$                          24.00	60.00%	$         240,000	$                  8.00	38.10%
	Contribution Margin	$                     480,000	$                          16.00	40.00%	$         960,000	$                13.00	61.90%
	Fixed Costs	$                     384,000			$         864,000
	Net Operating Income	$                       96,000			$           96,000
Part 2		Present	Proposed
a	Degree of Operating Leverage(Contribution Margin/Net operating income)	5	10
b	Break-even Point in $(Fixed Costs / Contribution Margin ratio)	$                     960,000	$                   1,395,800
c	Margin of Safety in dollars(Sales Revenue - Break-even Point in $)	$                     240,000	$                                -
	Margin of Safety in percentage(Margin of Safety / Sales Revenue)	20.00%	0.00%
Part 3	Break-even Point in units if upgrade is not done =$384,000 / $16 =24,000 units
	So at 24000 unis management will be indifferent
	Yes, Freidman should carry out the new upgrade as it results into an increase in contribution margin
Part 4		Amount
	Sales(33,000*$40)	$                  1,320,000
	Variable Costs	$                     792,000
	Contribution Margin	$                     528,000
	Fixed Costs($384,000+$36,000)	$                     420,000
	Net Operating Income	$                     108,000
	As it can be seen that the Net Operating Income has increased by $12,000, so the management should go with this plan