Question

Consolidated Industries is studying the addition of a new valve to its product line. The valve would be used by manufacturers of irrigation equipment. The company anticipates starting with a relatively low sales volume and then boosting demand over the next several years. A new salesperson must be hired because Consolidated’s current sales force is working at capacity. Two compensation plans are under consideration:

Plan A: An annual salary of $22,000 plus a 10% commission based on gross dollar sales.

Plan B: An annual salary of $66,000 and no commission.

Consolidated Industries will purchase the valve for $50 and sell it for $80. Anticipated demand during the first year is 6,000 units. (In the following requirements, ignore income taxes.)

1. Compute the break-even point in units for Plan A and Plan B.

3-a. Compute the operating leverage factor of both plans at the anticipated demand of 6,000 units. (Round your answers to 2 decimal places.)

4. Assume that a general economic downturn occurred during year 2, with product demand falling from 6,000 to 5,000 units. Determine the percentage decrease in company net income if Consolidated had adopted Plan A.

Plan A Profitability decrease by ________%

5. Assume that a general economic downturn occurred during year 2, with product demand falling from 6,000 to 5,000 units. Determine the percentage decrease in company net income if Consolidated had adopted Plan B. (Round your answer to 1 decimal place.)

Plan B profitability decrease by _______%

Answer 1

Question 1

Particulars	Plan A	Plan B
Fixed Costs	22,000	66,000
÷ Contribution Margin per Unit	22	30
Break Even Point in Units	1,000 Units	2,200 Units

Particulars	Plan A	Plan B
Sales Price per Unit	80	80
Less: Purchase Price per Unit	(50)	(50)
Less: Sales Commission per Unit	(8)	-
Contribution Margin per Unit	22	30

Sales Commission = 10% of Sales Price

= 10% of 80 = $ 8 per Unit

Question 3A

Particulars	Plan A	Plan B
Contribution Margin	132,000	180,000
÷ Operating Income	110,000	114,000
Operating Leverage Factor	1.2	1.58

Particulars	Plan A	Plan B
Contribution Margin per Unit	22	30
* Number of units	6,000	6,000
Contribution Margin	132,000	180,000

Particulars	Plan A	Plan B
Contribution Margin	132,000	180,000
Less: Fixed Costs	(22,000)	(66,000)
Operating Income	110,000	114,000

Question 4

% Change in Sales = Change in Sales / Base Level Sales *100

Change in Sales = 6,000 - 5,000 = 1,000 Units

Base Level Sales = 6,000 Units

% Change in Sales = 1,000 / 6,000 * 100

% Change in Sales = 16.67%

For Plan A

Operating Leverage Factor = % Change in Operating Income / % Change in Sales

1.2 = % Change in Operating Income / 16.67%

% Change in Operating Income = 1.2 * 16.67%

% Change in Operating Income = 20 %

Operating Income Decrease by 20 %

Question 5

Change in Sales = Change in Sales / Base Level Sales *100

Change in Sales = 6,000 - 5,000 = 1,000 Units

Base Level Sales = 6,000 Units

% Change in Sales = 1,000 / 6,000 * 100

% Change in Sales = 16.67

For Plan B

Operating Leverage Factor = % Change in Operating Income / % Change in Sales

1.58 = % Change in Operating Income / 16.67%

% Change in Operating Income = 1.58 * 16.67%

% Change in Operating Income = 26.32%

Operating Income Decrease by 26.3%