Question

Waterways is thinking of mass-producing one of its special-order sprinklers. To do so would increase variable costs for all sprinklers by an average of $0.70 per unit. The company also estimates that this change could increase the overall number of sprinklers sold by 10%, and the average sales price would increase $0.20 per unit. Waterways currently sells 481,000 sprinkler units at an average selling price of $25.20. The manufacturing costs are $5,811,160 variable and $2,155,660 fixed. Selling and administrative costs are $2,673,680 variable and $798,370 fixed.

If Waterways begins mass-producing its special-order sprinklers, how would this affect the company? (Round ratio to 0 decimal places, e.g. 5% and Net income to 0 decimal places, e.g. 2,520.)

DecreaseIncrease

Answer 1

Contribution Margin Ratio = Contribution per unit / Selling price per unit

Current Situation:

Variable cost per unit = total variable cost / number of units sold

= (5811160+2673680) / 481000

=8484840/ 481000= 17.64 Per unit

Contribution per unit = Selling price per unit - variable cost per unit

= 25.20 - 17.64 =7.56

Contribution Margin ratio =Contribution per unit /Selling price per unit

=7.56/25.20= 30.00%

Net Income = Total Contribution - Total fixed cost

= (481000 units x 7.56 )- (2,155,660 + 798,370)

= 3636360.00- 2954030.00 =682330.00

Present Situation :

Revised Variable cost = Variable cost per unit + average increased cost

= 17.64+0.70=18.34

Revised selling price per unit =selling price per unit + average increased cost

=25.20+0.20=25.40

Revised contribution per unit =Revised selling price per unit -Revised Variable cost

= 25.40-18.34 = 7.06

Revised contribution margin ratio = Revised contribution per unit/Revised selling price per unit

= 7.06/25.40 = 27.7953%

Revised Net Income = (units sold *110% *  Revised contribution per unit) - ( fixed cost)

= 481000x 110% x 7.06 - (2,155,660 + 798,370)

= 3735446.00 -2954030.00 = 781416.00

	Current	New	Effect
Contribution margin ratio	30%	27.80%	Decreases by 2.20% OR 2%
Net Income	682330.00	781416.00	Increases by 99086.00