Question

Waterways Problem 05

The Vice President for Sales and Marketing at Waterways Corporation is planning for production needs to meet sales demand in the coming year. He is also trying to determine how the company’s profits might be increased in the coming year. This problem asks you to use cost-volume-profit concepts to help Waterways understand contribution margins of some of its products and decide whether to mass-produce any of them.

Waterways markets a simple water control and timer that it mass-produces. Last year, the company sold 751,000 units at an average selling price of $4.90 per unit. The variable costs were $2,575,930, and the fixed costs were $772,779.

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 497,000 sprinkler units at an average selling price of $25.60. The manufacturing costs are $6,925,390 variable and $1,733,086 fixed. Selling and administrative costs are $2,617,010 variable and $783,290 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.) Current New Effect            Contribution margin ratio % % DecreaseIncrease by % Net income $ $ IncreaseDecrease by $

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 497,000 sprinkler units at an average selling price of $25.60. The manufacturing costs are $6,925,390 variable and $1,733,086 fixed. Selling and administrative costs are $2,617,010 variable and $783,290 fixed. If the average sales price per sprinkler unit did not increase when the company began mass-producing the special-order sprinkler, what would be the effect on the company? (Round answers to 0 decimal places, e.g. 5% or 2,520.) Contribution margin ratio IncreaseDecrease by % Profit IncreaseDecrease by $

Answer 1

Answer: For ease in solving the problem " Simple water control and timer is mentioned as " Product A" and " Special- order sprinkler is mentioned as " Product B".

                                  Income statement of Waterways Corporation ( at present level)

Contribution margin ratio = 26.12% or 26% (rounded off)

Scenario 1. Increase in selling price and increase in sales volume of Product B

                              Income statement of Waterways Corporation

                  (after increase in selling price and sales volume of Product B)

Contribution margin ratio = 29.71% or 30% (rounded off)

                                                      Compaarision Table

Scenario 2. Increase in sales volume but no increase in selling price of Product B

                              Income statement of Waterways Corporation

          (after increase in sales volume but no increase in selling price of Product B)

Contribution margin ratio = 29.27% or 29% (rounded off)

                                                    Comparison table

	Present Situation	Scenario 2	Increase / decrease
Contibution Margin ratio	26%	29%	3%
Net income	$995,615	$1,885,245	$889,630

Working note:

1. Sales revenue:

Sales revenue = Number of units sold x Selling price

Sales revenue for product A = 751,000 units x $4.90 = $3,679,900

Sales revenue for product B = 497,000 units x $25.60 = $12,723,200

2. Variable costs for Product B at present level:

Variable Manufacturing costs= $6,925,390

Variable Selling and administrative costs= $2,617,010

Total variable costs= $6,925,390 + $2,617,010

                                      = $9,542,400

3. Fixed costs for Product B at present level:

Fixed Manufacturing costs= $1,733,086

Variable Selling and administrative costs= $783,290

Total fixed costs= $1,733,086 + $783,290

                                = $2,516,376

4. New sales volume of product B:

Present sales volume = 497,000 units

Increase in sales volume = 10%

New sales volume = 497,000 + 10% of 497,000

                                     = 497,000 + 49,700 = 546,700 units

5. New selling price of product B and new sales revenue of product B after the increase in price and increase in sales :

Present price = $25.60

Increase in selling price = $0.20

New selling price = $25.80

New sales revenue of Product B = 546,700 units x $25.80

                                                                = $14,104,860

6. New variable costs for Product B:

Present expense for variable costs = $9,542,400

Increase in variable costs =$0.70 per unit

Total increase in variable costs = $0.70 x 546,700 units

                                                        = $382,690

New expense for variable costs = $9,542,400 + $382,690

                                                              = $9,925,090

7. Sales revenue of product B after increase in sales but without any increase in price:

New sales revenue of Product B = 546,700 units x $25.60

                                                                = $13,995,520

Sales volume Seling price Product A Product B Total 751,000 units 497,000 units $4.90 $25.60 $12,723,200 $16,403,100 | Sales revenue (Working note 1) | $3,679,900 Less: Variable costs Product A (given) ($2,575,930) Product B (Working note 2) Contribution margin $1,103,970 Less Fixed costs Product A (given) ($772,779) Product B (Working note 3) Profit $331,191 ($9,542,400)|($12,118,330) $3,180,800 $4,284,770 ($2,516,376) $664,424 ($3,289,155) $995,615

Total Product A Product B Sales volume (Working note 4) 1751,000 units 546,700 units Seling price (Working note 5) $14,104,860 $17,784,760 | Sales revenue (Working note 5) | $3,679,900 Less: Variable costs Product A (given) ($2,575,930) Product B (Working note 6) Contribution margin $1,103,970 Less Fixed costs Product A (given) ($772,779) Product B (Working note 3) Profit $331,191 ($9,925,090)|($12,501,020) $4,179,770 $5,283,740 ($2,516,376) $1,663,394 ($3,289,155) $1,994,585

Contibution Margin ratio Net income Present Situation Scenario 1 26% 30% $995,615 $1,994,585 Increase / decrease 4% $998,970

Sales volume Seling price Product A Product B Total 751,000 units 546,700 units $4.90 $25.60 $13,995,520 $17,675,420 | Sales revenue (Working note 7) | $3,679,900 Less: Variable costs Product A (given) ($2,575,930) Product B (Working note 6) Contribution margin $1,103,970 Less Fixed costs Product A (given) ($772,779) Product B (Working note 3) Profit $331,191 ($9,925,090)|($12,501,020) $4,070,430 $5,174,400 ($2,516,376) $1,554,054 ($3,289,155) $1,885,245

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Total Product A Product B Sales volume (Working note 4) 1751,000 units 546,700 units Seling price (Working note 5) $14,104,860 $17,784,760 | Sales revenue (Working note 5) | $3,679,900 Less: Variable costs Product A (given) ($2,575,930) Product B (Working note 6) Contribution margin $1,103,970 Less Fixed costs Product A (given) ($772,779) Product B (Working note 3) Profit $331,191 ($9,925,090)|($12,501,020) $4,179,770 $5,283,740 ($2,516,376) $1,663,394 ($3,289,155) $1,994,585

Contibution Margin ratio Net income Present Situation Scenario 1 26% 30% $995,615 $1,994,585 Increase / decrease 4% $998,970

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