Question

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

            
Sales (46,000 units × $27 per unit)   $   1,242,000     
Variable expenses      869,400     
Contribution margin      372,600     
Fixed expenses      298,080     
Net operating income   $   74,520     

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 $8.10 per unit. However, fixed expenses would increase to a total of $670,680 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 $475,686; and its net operating income would increase by 20%. Compute the company's break-even point in dollar sales under the new marketing strategy.

Answer 1

Solution:

1 & 2

Particulars	Present Operations		Automation
	Per Unit	Total	Per Unit	Total
Sales	27.00	1242000	27	1242000
Less: Variable Expenses	18.90	869400	0.8	36800
Contribution Margin	8.10	372600	26.2	1205200
Less: Fixed Expenses		298080		670680
Net Operating Income		74520		534520
DOL (Contribution Margin / Operating Income)		5		2.25
BEP (Dollar Sales) (Fixed Cost / CMratio)		993600		691159
Margin of safety in dollars (Total Sales - BEP Sales)		248400		550841
Margin of safety percentage (MOS dollars / Total Sales)		20%		44%

3. As a manager, the main factor that a manager should consider is the fluctuation of the operation to the economy’s growth. So that the decision whether to purchase the new equipment or not affecting on the financial figure as well as the efficient operation of a firm.

4.

Variable cost is not given, lets find

Profit = (Sales - variable expenses ) - Fixed Expenses

89424 = ( 1614600 - Variable expenses) - 475686

1614600-89424-475686 = Variable Expenses

Variable Expense = 1049490

Sales (units)	=46000(1+30%)
	59800 units
Sales Revenue 59800*27	$ 1614600

Net Operating Income	74520
Add: 20%	14904
New Operating Income	89424

Sales	1614600
Less: Variable Cost	1049490
Contribution Margin	565110
Fixed Cost	475686
CM Ratio	35.00%
BEP (Dollar Sales) (Fixed Cost / CMratio)	1359103