Question

 

The Hollywood Hat Company produces a top hat, the Star Topper that sells for $130. Operating income for 2018 is as follows:

Sales revenue ($130)	$910,000
Variable cost ($60 per hat)	420,000
Contribution margin	490,000
Fixed cost	380,000
Operating income	$110,000

Hollywood Hat Company would like to increase its profitability over the next year by at least 20%. To do so, the company is considering the following options:

Replace a portion of its variable labor with an automated machining process. This would result in a 20% decrease in variable cost per unit but a 15% increase in fixed costs. Sales would remain the same.

Spend $50,000 on a new advertising campaign, which would increase sales by 10%.

Increase both selling price by $10 per unit and variable costs by $8 per unit by using a higher-quality silk material in the production of its hats. The higher-priced hat would cause demand to drop by approximately 10%.

Add a second manufacturing facility that would double Hollywood Hat’s fixed costs but would increase sales by 60%.

Required

a. Evaluate each of the alternatives considered by Hollywood Hat.

b. Do any of the options meet or exceed Hollywood Hat’s targeted increase in income of 20%?

c. What should Hollywood Hat do?

Your answer should address each requirement (remember to show your work) and your submission should be in one Word file.

Answer 1

a.
	Present		Proposal 1		Proposal 2		Proposal 3		Proposal 4
Sales Volume	7000		7000		7700		6300		11200
	Per unit	Total	Per unit	Total	Per unit	Total	Per unit	Total	Per unit	Total
Sales	130	910000	130	910000	130	1001000	140	882000	130	1456000
Variable cost	60	420000	48	336000	60	462000	68	428400	60	672000
Contribution margin	70	490000	82	574000	70	539000	72	453600	70	784000
Fixed costs		380000		437000		430000		380000		760000
Operating Income		110000		137000		109000		73600		24000
Working:
1. For proposal 1 :
Variable cost per unit will reduce by 20% . The new variable cost per unit will be $48.00 ($60 reduced by 20% of $60)
Fixed cost will go up by 15%. The new fixed cost will be $437,000 ($380,000 * 1.15%)
2. For proposal 2 :
Sales will increase by 10%. The new sales will be 110% of 7,000 units i.e., 7,700 units.
Fixed cost will go up by $50,000 due to advertising expense of $50,000.
3. For proposal 3 :
Increasing selling price by $10 per unit, the new selling price will be $140 and increasing variable by $8 ,
the new variable cost per unit will be $68. This will reduce the demand by 10% to 6,300 units (90% of 7,000)
4. For proposal 4 :
Add a second manufacturing facility , which will double the fixed costs to $760,000( 2 x $380,000)
and increase in sales by 60% , new sales will be 11,200 ( 160% of 7,000).
b. Proposal 1 would meet the requirement of increasing net operating income by 20% .
Present operating income      = 110,000
20% increase                                  =22,000
Required operating income     =132,000
Operating income under proposal 1 = 137,000.
c. Since the firt proposal is giving the desired increase in operating income , the company shall go ahead with the proposal.