Question

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $80 per unit. Variable expenses are $40.00 per unit, and fixed expenses total $180,000 per year. Its operating results for last year were as follows:

Sales	$	2,000,000
Variable expenses		1,000,000
Contribution margin		1,000,000
Fixed expenses		180,000
Net operating income	$	820,000

Required:

Answer each question independently based on the original data:

5. The sales manager is convinced that a 10% reduction in the selling price, combined with a $67,000 increase in advertising, would increase this year's unit sales by 25%.

a. If the sales manager is right, what would be this year's net operating income if his ideas are implemented?

b. If the sales manager's ideas are implemented, how much will net operating income increase or decrease over last year?

6. The president does not want to change the selling price. Instead, he wants to increase the sales commission by $1.60 per unit. He thinks that this move, combined with some increase in advertising, would increase this year's sales by 25%. How much could the president increase this year's advertising expense and still earn the same $820,000 net operating income as last year?

Answer 1

3)
5)
Revised selling price ($80 [$80*10/100] = $72 per unit); ($2,000,000/$80 per unit = 25,000); (25,000*125/100 = 31,250* $72);	$2,250,000
Less: Variable expenses (31,250 * $40 per unit)	($1,250,000)
Contribution margin	$1,000,000
Less: Fixed Expenses ($180,000 + $67,000)	($247,000)
Net operating income	$753,000
a) The decision of the sales manager is wrong because decreasing the selling price per unit by 10% resulting increase of 25% sales in units and increase of $67,000 in advertising costs will decrease the net operating income from $820,000 to $753,000.
The net operating income is $753,000, if the idea was implemented.
b) If the sales manage ideas are implmented, the net operating income will decrease by $67,000 ($820,000 - $753,000).
6)
Sales Revenue	$2,250,000
Less: Variable costs ($40 - $1.60 = $38.40 * 31,250 units)	($1,200,000)
Revised contribution margin	$1,050,000
Increase in fixed costs ($1,000,000 - $1,050,000)	$50,000
Therefore, the increase in fixed costs is $50,000.
Here it is proved -
Sales Revenue	$2,250,000
Less: Variable costs ($40 - $1.60 = $38.40 * 31,250 units)	($1,200,000)
Revised contribution margin	$1,050,000
Less: Revised fixed costs ($180,000 + $50,000)	($230,000)
Net operating income	$820,000