In: Accounting
Data for Hermann Corporation are shown below
Per Unit Percent of Sales
Selling price $ 80 100 %
Variable expenses 44 55
Contribution margin $ 36 45 %
Fixed expenses are $76,000 per month and the company is selling 2,500 units per month.
2-a. Refer to the original data. How much will net operating income increase (decrease) per month if the company uses higher-quality components that increase the variable expense by $4 per unit and increase unit sales by 20%.
2-b. Should the higher-quality components be used?
Original Data:
Selling Price (100%) = $80
Variable Expense (55%) = $44
Contribution Margin (45%) = 36
Fixed Expense = $76000 per month
Number of unit sold per month = 2500
Particulars |
Amount($) |
Sale(2500*80) |
200000 |
Less: Variable Expense (200000*55%) |
110000 |
Contribution (45%) |
90000 |
Less: Fixed Expense |
76000 |
Operating income |
14000 |
Percentage of operating income on sale = 14000/200000 = 7%
2-a. Computation of operating income If Variable expense increase by $4 and sales by 20%:
Number of units sold after 20% increase in sales = 2500 + 2500*20% = 2500 + 500 = 3000 units
Variable cost for 3000 units = (44+4)*3000 = 144000
Particulars |
Amount($) |
Sale |
240000 |
Less: Variable Expense |
144000 |
Contribution (40%) |
96000 |
Less: Fixed Expense |
76000 |
Operating income |
20000 |
Percentage of operating income on sale = 20000/240000 = 8.33%
Net increase in operating income = 20000 -14000 = 6000
Net increase in operating income in percentage by 1.33% (8.33%-7%).
2-b. Yes, Hermann Corporation should use higher quality components because there is increase in net operating income by $6000.