Question

Data for Hermann Corporation are shown below: Per Unit Percent of Sales Selling price $ 110 100 % Variable expenses 77 70 Contribution margin $ 33 30 % Fixed expenses are $82,000 per month and the company is selling 3,500 units per month. Exercise 6-5 Part 2 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 $5 per unit and increase unit sales by 20%. 2-b. Should the higher-quality components be used?

Answer 1

Current position

Selling price per unit = $110

Variable cost per unit = $77

Contribution margin per unit = $33

Fixed expense = $82,000

Number of units sold = 3,500

Calculation of Income Statement
Sales (3,500 x 110)	385,000
Variable cost (3,500 x 77)	-269,500
Contribution margin	115,500
Fixed expense	-82,000
Net operating income	33,500

Proposed position

Increase in variable cost per unit = $5

New variable cost per unit = Old variable cost per unit + Increase in variable cost per unit

= 77+5

= $82

Increase in units sales = 20%

= 3,500 x 20%

= 700

Number of units = 3,500+700

= 4,200 units

Calculation of Income Statement
Sales (4,200 x 110)	462,000
Variable cost (4,200 x 82)	-344,400
Contribution margin	117,600
Fixed expense	-82,000
Net operating income	35,600

Net operating income will increase by = 35,600-33,500

= $2,100

Higher quality component should be used.