Question

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

Sales (45,000 units × $25 per unit)	$	1,125,000
Variable expenses		787,500
Contribution margin		337,500
Fixed expenses		270,000
Net operating income	$	67,500

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:

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 $7.50 per unit. However, fixed expenses would increase to a total of $607,500 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. (Round your "Per unit" answers to 2 decimal places.)

Sales

variable expenses

Contribution margin

fixed expenses

2.Refer to the income statements in (1) above. For both present operations and the proposed new operations, compute

a. The degree of operating leverage.

Present Proposed

Degree of operating leverage=

b. The break-even point in dollar sales.

Present Proposed

Break-even point in dollar sales =

c. The margin of safety in both dollar and percentage terms.

Present Proposed

Margin of safety in dollar sales  

Margin of safety in percentage % %

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

	Cyclical movements in the economy
	Performance of peers in the indstry
	Stock level maintained
	Reserves and surplus of the company

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 50% without any change in selling price; the company’s new monthly fixed expenses would be $337,500, and its net operating income would increase by 25%. Compute the break-even point in dollar sales for the company under the new marketing strategy.

New break even point in dollar sales = ?

Answer 1

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Part 1
		Present		New
		Per unit	Total	Per unit	Total
Sales (45,000 units × $25 per unit)		$         25.00	$1,125,000	$         25	$1,125,000
Variable expenses		$         17.50	$   787,500	$         10	$   450,000
Contribution margin		$           7.50	$   337,500		$   675,000
Fixed expenses			$   270,000		$   607,500
Net operating income			$     67,500		$     67,500
Part 2a
			Present		New
Contribution margin		a	$   337,500		$   675,000
Net operating income		b	$     67,500		$     67,500
Degree of operating Leavarage		a/b	5.00		10.00
Part 2b
			Present		New
Contribution margin Ratio		a	30.00%		60.00%
(Contribution margin/Sales)
Fixed Expense		b	$   270,000		$   607,500
Break Even point-Dollar Sale		b/a	$   900,000		$1,012,500
Part 3
Actual Sale		a	$1,125,000		$1,125,000
Break Even Sale		b	$   900,000		$1,012,500
Margin of Safety-Dollar		a-b=c	$   225,000		$   112,500
Margin of Safety-Percent		c/a	20.00%		10.00%
Part 4
New Sales		$ 1,687,500
($1,125,000*1.5)
New Net Operating Income		$       84,375
$67,500*1.25)
Variable Expense		$ 1,265,625
(Sale-Fixed Expense-Profit)
$1,687,500-$84,375-$337,500
Sales		$ 1,687,500
Less: Variable Expense		$-1,265,625
Contribution Margin		$     421,875
Contribution Margin Ratio		25.00%
Break Even Point in Dollar Sale		$ 1,350,000
$337,500/25%