Question

Broadening Your Perspective 6-2 (Part Level Submission) For nearly 20 years, Specialized Coatings has provided painting and galvanizing services for manufacturers in its region. Manufacturers of various metal products have relied on the quality and quick turnaround time provided by Specialized Coatings and its 20 skilled employees. During the last year, as a result of a sharp upturn in the economy, the company’s sales have increased by 30% relative to the previous year. The company has not been able to increase its capacity fast enough, so Specialized Coatings has had to turn work away because it cannot keep up with customer requests. Top management is considering the purchase of a sophisticated robotic painting booth. The booth would represent a considerable move in the direction of automation versus manual labor. If Specialized Coatings purchases the booth, it would most likely lay off 15 of its skilled painters. To analyze the decision, the company compiled production information from the most recent year and then prepared a parallel compilation assuming that the company would purchase the new equipment and lay off the workers. Those data are shown below. As you can see, the company projects that during the last year it would have been far more profitable if it had used the automated approach.

Current Approach Automated Approach

Sales $1,560,000 $1,560,000

Variable costs 1,170,000 780,000

Contribution margin 390,000 780,000

Fixed costs 296,000 624,000

Net income $94,000 $156,000

Collapse question part (a1. Compute the contribution margin ratio under each approach. (Round ratios to 0 decimal places, e.g. 15%.) Current approach Automated approach Contribution margin ratio Entry field with correct answer 25 %, 50 % Collapse question part (b1)

Compute the break-even point in sales dollars under each approach. Current approach Automated approach Break-even points in sales dollars $ 1184000 $1248000

Collapse question part (c1) Using the current level of sales, compute the margin of safety ratio under each approach. (Round ratios to 0 decimal places, e.g. 15%.) Current approach Automated approach Margin of safety ratio 24 % 20 %

Collapse question part (d) Determine the degree of operating leverage for each approach at current sales levels. (Round answers to 2 decimal places, e.g. 2.25.) Current approach Automated approach Degree of operating leverage

How much would the company’s net income (increase or decrease) under each approach with a 10% decline in sales? (Round answers to 1 decimal place, e.g. 22.5%.) For a 10% drop in sales net income would by % for Current approach For a 10% drop in sales net income would by % for Automated approach

Answer 1

a1:

	Current approach	Automated approach
Sales (a)	1,560,000.00	1,560,000.00
less: variable costs	1,170,000.00	780,000.00
Contribution margin (b)	390,000.00	780,000.00
Contribution margin ratio = (b)/(a)	25.00	50.00

b1:

	Current approach	Automated approach
Fixed costs (a)	296,000.00	624,000.00
Contribution margin ratio (b)	25.00	50.00
Break even point (a)/(b*100)	1,184,000.00	1,248,000.00

c1:

	Current approach	Automated approach
Sales (a)	1,560,000.00	1,560,000.00
less: breakeven sales	1,184,000.00	1,248,000.00
Margin of safety (b)	376,000.00	312,000.00
Margin of dafety ratio (b/a)*100	24	20

d:

	Current approach	Automated approach
Contribution margin (a)	390,000.00	780,000.00
Net income (b)	94,000.00	156,000.00
Operating leverage (a/b)	4.15	5.00

Now if a 10% decline in sales happens then:

Current approach net income = sales - (variable costs+fixed costs)

Sales after 10% decline = 1,560,000*(1-10%) = $1,404,000

Variable costs will also decline by 10% and changed variable costs = 1170000*(1-10%) = 1,053,000. Fixed costs will remain the same.

Thus Current approach net income = 1,404,000-(1,053,000+296,000) = 55,000. Net income before decline = 1560000-1170000-296000 = 94,000.

Thus % decline in net income = (94000-55000)/94000 = 41.5% (decline)

Automated appro

Net income before any decline = 1560000-780000-624000 = 156,000

Sales after 10% decline = 1560000*(1-10%) = 1,404,000. New variable costs = 780,000*(1-10%) = 702,000

Thus net income after 10% drop in sales = 1404000-702000-624000 = 78000

Thus % drop in sales = (156000-78000)/156000 = 50.0% (decline)