Question

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Data for Hermann Corporation are shown below:

	Per Unit			Percent of Sales
Selling price	$	140		100%
Variable expenses		91		65%
Contribution margin	$	49		35%

   

Fixed expenses are $88,000 per month and the company is selling 3,000 units per month. Required: 1-a. The marketing manager argues that a $9,300 increase in the monthly advertising budget would increase monthly sales by $21,500. Calculate the increase or decrease in net operating income.        1-b. Should the advertising budget be increased? Yes No 2-a. Refer to the original data. Management is considering using higher-quality components that would increase the variable expense by $6 per unit. The marketing manager believes that the higher-quality product would increase sales by 20% per month. Calculate the change in total contribution margin. 2-b. Should the higher-quality components be used? Yes No

Answer 1

Answer:-1a)- Net operating income will decrease by $1775 (ie-$59000-$57225)

1b)- Hence advertising budget should not be increased.

Explanation:-

Hermann Corporation
Statement of Net opreating income
Particlulars	Current situation	Sale with additional advertising budget
	$	$
Sales value	3000 units*$140 per unit =420000	420000+21500=441500
Less:- Variable costs	3000 units*$91 per unit =273000	441500*65% =286975
Contribution	147000	154525
Less:- Fixed costs	88000	88000+9300 = 97300
Net opreating income	59000	57225

1a)- The contribution margin will increase by $66000 (ie-$213000-$147000)

1b)- Hence high quality components should be used.

Explanation:-

Hermann Corporation
Statement of Net opreating income
Particlulars	Current situation	Proposed situation
	$	$
Sales value	3000 units*$140 per unit =420000	420000*120%=504000
Less:- Variable costs	3000 units*$91 per unit =273000	3000 units*$97 per unit =291000
Contribution	147000	213000
Less:- Fixed costs	88000	88000
Net opreating income	59000	125000