Question

The Vice President for Sales and Marketing at Waterways Corporation is planning for production needs to meet sales demand in the coming year. He is also trying to determine how the company’s profits might be increased in the coming year. This problem asks you to use cost-volume-profit concepts to help Waterways understand contribution margins of some of its products and decide whether to mass-produce any of them.

Waterways markets a simple water control and timer that it mass-produces. Last year, the company sold 720,000 units at an average selling price of $4.70 per unit. The variable costs were $2,030,400, and the fixed costs were $879,840.

1. If sales increase by 55,000 units and the cost behaviors do not change, how much will income increase on this product?

Income would increase by $___________?

2. Waterways is thinking of mass-producing one of its special-order sprinklers. To do so would increase variable costs for all sprinklers by an average of $0.70 per unit. The company also estimates that this change could increase the overall number of sprinklers sold by 10%, and the average sales price would increase $0.20 per unit. Waterways currently sells 496,000 sprinkler units at an average selling price of $27.80. The manufacturing costs are $7,654,360 variable and $1,991,155 fixed. Selling and administrative costs are $2,687,240 variable and $796,450 fixed.

If Waterways begins mass-producing its special-order sprinklers, how would this affect the company?

	Current	New	Effect
Contribution margin ratio	______ %	______%	increase or decrease	____%
Net Income	$_______	$_______	increase or decrease	$_______

3. Waterways is thinking of mass-producing one of its special-order sprinklers. To do so would increase variable costs for all sprinklers by an average of $0.70 per unit. The company also estimates that this change could increase the overall number of sprinklers sold by 10%, and the average sales price would increase $0.20 per unit. Waterways currently sells 496,000 sprinkler units at an average selling price of $27.80. The manufacturing costs are $7,654,360 variable and $1,991,155 fixed. Selling and administrative costs are $2,687,240 variable and $796,450 fixed.

If the average sales price per sprinkler unit did not increase when the company began mass-producing the special-order sprinkler, what would be the effect on the company?

Contribution margin ratio	increase or decrease	__________%
Profit	increase or decrease	$__________

Answer 1

Ans.

1. Variable Expense =  $2,030,400

Variable Expense per unit = $2,030,400 / 720,000 = 2.82

Contribution Margin = Selling Price - Variable Expense

Contribution Margin = $ 4.7 - $ 2.82 = $ 1.88

Income would increase by 55,000 * 1.88 = $ 103,400

2.

New sales unit = 496,000 + 10% = 545,600 units

sales price per unit = $27.80 + $0.20 = $ 28

Variablecost

Total Variable (manufacturing cost+Selling administrative) cost per unit = ( $7,654,360+ $2,687,240) / 496,000 units

= $ 10,341,600 / 496,000 = $ 20.85

Increase insales level

sales (545,600 unit * $28) = $ 15,276,800

less: Total variable cost [545,600 unit * ($ 20.85 +$0.70)] = $ 11,757,680

Contribution = $ 3,519,120

less: Total fixed cost ( $1,991,155 + $796,450  ) = $ 2,787,605

Net operating income = $ 731,515

Current sales level

Sales(496,000 units * $27.8) = $13,788,800

less: variable cost($7,654,360+ $2,687,240 ) = $ 10,341,600

Contribution = $ 3,447,200

less: Fixed cost ($1,991,155 + $796,450) = $ 2,787,605

Net operating income = $ 659,595

	Current	New	Effect
Contribution margin ratio (Contribution / Sales)*100	25%	23.04%	Decrease	1.96%
Net Income	$659,595	$731,515	Increase	$71,920

3.

sales (545,600 unit * $27.8) = $ 15,167,680

less: Total variable cost [545,600 unit * ($ 20.85 +$0.70)] = $ 11,757,680

Contribution = $ 3,410,000

less: Total fixed cost ( $1,991,155 + $796,450  ) = $ 2,787,605

Net operating income = $ 622,395

	Current	New	Effect
Contribution margin ratio (Contribution / Sales)*100	25%	22.48%	Decrease	2.52%
Net Income	$659,595	$622,395	Decrease	$37,200