Question

Morton Company’s contribution format income statement for last month is given below:

Sales (45,000 units × $28 per unit)	$	1,260,000
Variable expenses		882,000
Contribution margin		378,000
Fixed expenses		302,400
Net operating income	$	75,600

The industry in which Morton Company operates is quite sensitive to cyclical movements in the economy. Thus, profits vary considerably from year to year according to general economic conditions. The company has a large amount of unused capacity and is studying ways of improving profits.

Required:

1. New equipment has come onto the market that would allow Morton Company to automate a portion of its operations. Variable expenses would be reduced by $8.40 per unit. However, fixed expenses would increase to a total of $680,400 each month. Prepare two contribution format income statements, one showing present operations and one showing how operations would appear if the new equipment is purchased.

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

3. Refer again to the data in (1). As a manager, what factor would be paramount in your mind in deciding whether to purchase the new equipment? (Assume that enough funds are available to make the purchase.)

4. Refer to the original data. Rather than purchase new equipment, the marketing manager argues that the company’s marketing strategy should be changed. Rather than pay sales commissions, which are currently included in variable expenses, the company would pay salespersons fixed salaries and would invest heavily in advertising. The marketing manager claims this new approach would increase unit sales by 30% without any change in selling price; the company’s new monthly fixed expenses would be $482,580; and its net operating income would increase by 20%. Compute the company's break-even point in dollar sales under the new marketing strategy.

Req 1

	Morton Company Contribution Income Statement Present Proposed Amount Per Unit % Amount Per Unit % % % % % % %

Req2

	Present Proposed a. Degree of operating leverage b. Break-even point in dollar sales c. Margin of safety in dollars Margin of safety in percentage % %

Req 3

	Cyclical movements in the economyradio button unchecked1 of 4 Reserves and surplus of the companyradio button unchecked2 of 4 Performance of peers in the industryradio button unchecked3 of 4 Stock level maintainedradio button unchecked4 of 4

Re4

	New break even point in dollar sales

Answer 1