Question

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

Sales (42,000 units)	$	1,050,000
Variable expenses		630,000
Contribution margin		420,000
Fixed expenses		378,000
Operating income	$	42,000

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 $420,000 per month. However, variable expenses would decrease by $10 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 $42,000 per month. Management believes the new advertisements will increase monthly unit sales by 15%. In this case what would be imapact on operating income.

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

• Yes

• No

Answer 1

Please Note - All figures are in "$"

		Requirement (1)
FRIEDEN Company
Contribution Income Statement
	Present	Proposed
Particulars	Amount	Per Unit	CMR	Amount	Per Unit	CMR
Sales	1,050,000	25		1,050,000	25
Less: Variable Cost	630,000	15		210,000	5
Contribution	420,000	10	40%	840,000	20	80%
Less: Fixed Cost	378,000			798,000
Income	42,000			42,000
* CMR= Contribution Margin Ratio
Requirement (2 a)
Particulars	Present	Proposed
Degree of operating leverage		10	20
(Contribution/income)
Requirement (2 b)
Particulars	Present	Proposed
Break Even Point	945000	997500
(Fixed Cost/CMR)
Requirement (2 c)
Particulars	Present	Proposed
Margin of Safety(In Dollars)	105,000	52,500
(Sales-Break Even point)
Margin of Safety(In percentage)	10	5
** Margin of safety (in %)=margin (in dollars)/sales
		Requirement - 3(a)
Indifferent point of Sales will be at 42000 units as Income remains the same when
calculated before upgradation and after upgradation
		Requirement - 3(b)
Frieden should proceed with the upgrade
		Requirement - 3(c)
At the upgradation contribution margin will increase from 40 percent to 80 percent , so when the sale will increrase form the current level Frieden will earn more income as the fixed cost will remain constant at $ 798,000.