Question

Morton Company’s contribution format income statement for last month is given below: Sales (49,000 units × $30 per unit) $ 1,470,000 Variable expenses 1,029,000 Contribution margin 441,000 Fixed expenses 352,800 Net operating income $ 88,200 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 $9.00 per unit. However, fixed expenses would increase to a total of $793,800 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.)

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. b. The break-even point in dollar sales. c. The margin of safety in both dollar and percentage terms.

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

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 $441,000, 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.

Answer 1

		present		Proposed
sales		1470000		1470000
less variable cost		1029000	12	588000
contribution margin		441000		882000
less fixed cost		352800		793800
EBIT		88200		88200
degree of operating leverage	contribution margin/ebit	5		10
Break even point in dollar sales	fixed cost/contribution margin ratio	1176000		1323000
contribution margin ratio	contribution/selling price	0.30		0.60
Margin of safety = sales- break even sales		294000		147000
Margin of safety in %	margin of safety/sales	20.00%		10.00%
company should see that what is required rate of return and investment in machine is offering return equal to more than the required return if it is more than the required return it should be accepted or purchased
		Proposed
sales		2205000
less variable cost		1029000
contribution margin		1176000
less fixed cost		441000
EBIT		735000
contribution margin ratio	contribution/sales	0.533333
break even sales in dollar	fixed cost/contribution margin ratio	826875