Question

Frieden Company's contribution format income statement for last month is shown below:

Sales (35,000 units)	$	700,000
Variable expenses		490,000
Contribution margin		210,000
Fixed expenses		189,000
Operating income	$	21,000

Competition is intense, and Frieden Company’s profits vary considerably from one year to the next. Management is exploring opportunities to increase profitability.

Required:

1. Frieden’s management is considering a major upgrade to the manufacturing equipment, which would result in fixed expenses increasing by $210,000 per month. However, variable expenses would decrease by $6 per unit. Selling price would not change. Prepare two contribution format income statements, one showing current operations and one showing how operations would appear if the upgrade is completed. Show an Amount column, a Per Unit column, and a Percentage column on each statement.

2. Refer to the income statements in requirement 1 above. For both current operations and the proposed new operations, compute (a) the degree of operating leverage, (b) the break-even point in dollars, and (c) the margin of safety in both dollar and percentage terms.

3-a. Calculate the unit sales per month at which Frieden management will be indifferent between doing the major upgrade to the manufacturing equipment and not doing the upgrade.

3-b. Based on the above analysis, should Frieden proceed with the major upgrade?

multiple choice 1

• Yes

• No

3-c. Why or why not?

4-a. Refer to the original data. Instead of doing the major upgrade to the equipment, management is considering introducing a new advertising campaign that will increase fixed expenses by $38,000 per month. Management believes the new advertisements will increase monthly unit sales by 20%. In this case what would be imapact on operating income.

4-b. Should Frieden proceed with the new advertising campaign?

multiple choice 2

• Yes

• No

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Answer 1

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Frieden Company
Workings for Answer 1	Amount $	Note
Variable expenses	490,000.00	A
Units sold	35,000.00	B
Variable expense per unit	14.00	C=A/B
Variable expense per unit	14.00	See C
Less: Reduction by	6.00
Revised Variable expense per unit	8.00	D
Units sold	35,000.00	See A
Variable expenses	280,000.00	E=D*A

Answer 1	Present		Proposed
Income statement	Amount	Per Unit	%	Amount	Per Unit	%	Note
Sales	700,000.00	20.00	100.00%	700,000.00	20.00	100.00%
Less: Variable expense	490,000.00	14.00	70.00%	280,000.00	8.00	40.00%	See E
Contribution margin	210,000.00	6.00	30.00%	420,000.00	12.00	60.00%	F
Less: Fixed expenses	189,000.00			399,000.00
Net Operating income	21,000.00		3.00%	21,000.00		3.00%	G

Answer 2	Present	Proposed
Sales	700,000.00	700,000.00	H
Contribution margin	210,000.00	420,000.00	I
Fixed expenses	189,000.00	399,000.00	J
Net Operating income	21,000.00	21,000.00	See G
Degree of operating leverage	10.00	20.00	K=I/G
Contribution margin %	30.00%	60.00%	L=I/H
Break-even point in dollar sales	630,000.00	665,000.00	M=J/L
Margin of safety in dollars	70,000.00	35,000.00	N=H-M
Margin of safety %	10.00%	5.00%	O=N/H

Answer 3- a

Unit sales per month is 35,000 because operating income is same in both cases at this level.

Answer 3- b

Operating income is same so should not upgrade.

Answer 4 a	Amount $	Note
Current contribution	210,000.00	See F
Increase by 20%	42,000.00	P=F*20%
Less: Cost of new advertising campaign	38,000.00
Increase in operating income by	4,000.00

Answer 4 b

Operating income will increase by $ 4,000 so Frieden should proceed with the new advertising campaign.