Question

roblem 11-40 Profitability Analysis; Pro Forma Income Statement [LO 11-5, 11-7]

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RayLok Incorporated has invented a secret process to improve light intensity and, as a result, manufactures a variety of products related to this process. Each product is independent of the others and is treated as a separate profit/loss division. Product (division) managers have a great deal of freedom to manage their divisions as they think best. Failure to produce target divisional income is dealt with severely; however, rewards for exceeding one’s profit objective are, as one division manager described them, lavish.

The DimLok Division sells an add-on automotive accessory that automatically dims a vehicle’s headlights by sensing a certain intensity of light coming from a specific direction. DimLok has had a new manager in each of the 3 previous years because each manager failed to reach RayLok’s target profit level. Donna Barnes has just been promoted to manager and is studying ways to meet the current target profit for DimLok.

DimLok’s two profit targets for the coming year are $1,500,000 (30% return on the investment in the annual fixed costs of the division) and $40 (pre-tax) profit for each DimLok unit sold. Other constraints on the division’s operations are as follows:

• Production cannot exceed sales because RayLok’s corporate advertising program stresses completely new product models each year, although the models might have only cosmetic changes.
• DimLok’s selling price cannot vary above the current selling price of $240 per unit but may vary as much as 5% below $240.
• A division manager can elect to expand fixed production or selling facilities; however, the target profit objective related to fixed costs is increased by 30% of the cost of any such expansion. Furthermore, a manager cannot expand fixed facilities by more than 40% of existing fixed cost levels without approval from the board of directors.

Donna is now examining data gathered by her staff to determine whether DimLok can achieve its target profits of $1,500,000 and $40 per unit. A summary of these reports shows the following:

• Last year’s sales were 43,000 units at $240 per unit.
• DimLok’s current manufacturing facility capacity is 53,000 units per year, but can be increased to 106,000 units per year with an increase of $1,130,000 in annual fixed costs.
• Present variable costs amount to $100 per unit, but DimLok’s vendors are willing to offer direct materials discounts amounting to $15 per unit, beginning with unit number 73,001.
• Sales can be increased up to 126,000 units per year by committing large blocks of product to institutional buyers at a discounted unit price of $225. However, this discount applies only to sales in excess of 53,000 units per year.

Donna believes that these projections are reliable and is now trying to determine what DimLok must do to meet the profit objectives assigned by RayLok’s board of directors.

Part 1

Required:

1. Determine the dollar amount of DimLok’s present annual fixed costs per year.

2. Determine the number of units that DimLok must sell to achieve both profit objectives. Be sure to consider all constraints in determining your answer.

3. Without regard to your answer in requirement 2, assume that Donna decides to sell 53,000 units at $240 per unit and 29,690 units at $225 per unit.

(a) Prepare a budgeted income statement (contribution format) for DimLok showing budgeted operating income.

(b) Would this projected operating income meet the stated profit objectives?

Answer 1

1.

Current Fixed Cost

Profit target ar 30% on fixed cost = $1,500,000

Fixed Cost is (Profit / 30%) = $5,000,000

2.

A	Selling Price	$240
B	Variable Cost	$100
C	Contribution per unit (A-B)	$140
D	Profit per Dimlock	$40
E	Revised Contribution per Dimlok (C-D)	$100
F	Fixed cost and profit needed (5,000,000+1,500,000)	$6,500,000
G	Number of Dimlok to be sold [(Fixed cost + profit) / contribution per dimlok] (F/E)	$65000

Since units is exceeding capacity of 58000 units fixed cost will increase by $1,130,000 per year

A	Revised Fixed cost ($5,000,000+$1,130,000)	$6,130,000
B	Profit at 30% on above(A x 30/100)	$1,839,000
C	Total (A+B)	$7,969,000
D	Contribution per Dimlok	$100
E	Numbrt of Dimlok to be sold (C/D)	79690 Units

Cross Checking

A	Sales - (79690 units x $240)	$19,125,600
B	Less: Variable Cost (79690 x $100)	$7,969,000
C	Contribution (A-B)	$11,156,600
D	Fixed Cost (Revised)	$6,130,000
E	Net Profit (C-D)	$5,026,600
F	30% on Fixed Cost	$1,839,000
G	Profit at $40 on Dimlok Sold (79690 x $40)	$3,187,600
H	Total Profit Achieved (F+G)	$5,026,600

3a)

Budgeted Income Statement

Sales (53000 x $240) (29690 (WN-1) x $225) Total Sales	$12,720,000 $6,680,250	$19,400,250
Less:Variable Cost (73000 x $100) (9690 (WN-2) x $(100-15) Total Variable cost	$7,300,000 $823.650	($8,123,650)
Contribution		$11,276,600
Less: Fixed Cost (Revised)		($6,130,000)
Net Profit		$5,146,600

WN - 1

Given in Question 53000 units and 29690 units

So Total 82690 Units

Actually 29690 = 82690 - 53000

WN - 2

Variable Cost 73000 given in Question

So, 9690 = 82690 - 73000

3b)

Profit Objective is acheived

Profit Required

ROI on Fixed Cost - 30% = $1,839,000 ($6,130,000 x 30/100)

Profit if $40 per Dimlok = $3,307,600 ($82690 x $40)

Total Profit = $5,146,600 ($1,839,000 + $3,307,600)