Question

A company makes a product that sells for $80 per unit. Variable expenses are $40.00 per unit, and fixed expenses total $180,000 per year. Its operating results for last year were as follows:

Sales	$	2,080,000
Variable expenses		1,040,000
Contribution margin		1,040,000
Fixed expenses		180,000
Net operating income	$	860,000

The company president wants to add new features to the product, which will increase the variable expenses by $2.30 per unit. She thinks that the new features, combined with some increase in marketing spending, would increase this year's sales by 25%. How much could the president increase this year's fixed marketing expense and still earn the same $860,000 net operating income as last year?

Answer 1

Calculation of increase in fixed marketing expense to earn the same $ 860,000 net operating income as last year is as follows:

Increase in Fixed Marketing expense = Contribution margin - Fixed expesnes - Net operating income

= $ 1,225,250 - $ 180,000 - $ 860,000

= $ 185,250

Thus, Company should increase in fixed marketing expese by $ 185,250 to have same $ 860,000 net operating income as last year.

Working note:

Calculation of contribution margin :

Contribution margin = Sales * Contribution margin per unit

= 32,500 * $ 37.7

= $ 1,225,250

Increases in variable cost by $ 2.30per unit. Thus, Total variable cost per unit will be $ 42.30 ( $ 40 + $ 2.30 )

Contribution margin per unit = Selling price per unit - Variable cost per unit

= $ 80 - $ 42.30

= $ 37.7

Company expects sales increases by 25%

Sales units = Current sales + 25%

= 26,000 + 25%

= 32,500 units

Current sales units = Total sales / selling price per unit

= $ 2,080,000 / $ 80

= 26,000 units