Question

Morton Company’s contribution format income statement for last month is given below:

Sales (44,000 units × $22 per unit)	$	968,000
Variable expenses		677,600
Contribution margin		290,400
Fixed expenses		232,320
Net operating income	$	58,080

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: #4 only please

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 $6.60 per unit. However, fixed expenses would increase to a total of $522,720 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.

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

3. Refer again to the data in (1). 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.)

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 30% without any change in selling price; the company’s new monthly fixed expenses would be $370,744; and its net operating income would increase by 20%. Compute the company's break-even point in dollar sales under the new marketing strategy.

Answer 1

(4):

The orginal scenario is:

	Total	Per unit = Total/44,000
Sales	968,000.00	22.00
Less: variable expenses	677,600.00	15.40
Contribution margin	290,400.00	6.60
less: Fixed expenses	232,320.00
Net operating income	58,080.00	1.32

Now in case of situation in "4" new unit sales = (1+30%)*44000 = 57,200 units. Thus total sales = 57,200 units * $22 per unit = 1,258,400

New fixed expenses = 370,744 (as given) and new operating income = 58,080*(1+20%) = 69,696

Let total variable expenses be "x". Thus 1,258,400 - x - 370,744 = 69,696

or x = 817,960

	Total	Per unit = Total/57200
Sales	1,258,400	22.00000
Less: variable expenses	817,960	14.30000
Contribution margin	440,440	7.70000
less: Fixed expenses	370,744
Net operating income	69,696	1.21846

Break even = Total fixed costs/(selling price per unit - variable cost per unit)

= 370,744/(22-14.30)

= 48,148.57 units

Thus break even point in $ sales = 48,148.57 units*$22 per unit

= $1,059,268.57

We can also use the formula: Break even in $ sales = fixed costs/CM ratio

CM ratio = contribution margin per unit/sales price price unit = 7.7/22 = 0.35

Thus break even point in $ sales = 370,744/0.35

= $1,059,268.57

Thus break even sales is $1,059,268.57. It can be rounded to nearest dollar amount of $1,059,269