Question

RayLok Incorporated has invented a secret process to improve light intensity and, as a result, manufactures a variety of products related to this process. Each product is independent of the others and is treated as a separate profit/loss division. Product (division) managers have a great deal of freedom to manage their divisions as they think best. Failure to produce target divisional income is dealt with severely; however, rewards for exceeding one’s profit objective are, as one division manager described them, lavish.

The DimLok Division sells an add-on automotive accessory that automatically dims a vehicle’s headlights by sensing a certain intensity of light coming from a specific direction. DimLok has had a new manager in each of the 3 previous years because each manager failed to reach RayLok’s target profit level. Donna Barnes has just been promoted to manager and is studying ways to meet the current target profit for DimLok.

DimLok’s two profit targets for the coming year are $910,000 (25% return on the investment in the annual fixed costs of the division) and $30 (pre-tax) profit for each DimLok unit sold. Other constraints on the division’s operations are as follows:

• Production cannot exceed sales because RayLok’s corporate advertising program stresses completely new product models each year, although the models might have only cosmetic changes.
• DimLok’s selling price cannot vary above the current selling price of $200 per unit but may vary as much as 5% below $200.
• A division manager can elect to expand fixed production or selling facilities; however, the target profit objective related to fixed costs is increased by 25% of the cost of any such expansion. Furthermore, a manager cannot expand fixed facilities by more than 35% of existing fixed cost levels without approval from the board of directors.

Donna is now examining data gathered by her staff to determine whether DimLok can achieve its target profits of $910,000 and $30 per unit. A summary of these reports shows the following:

• Last year’s sales were 41,000 units at $200 per unit.
• DimLok’s current manufacturing facility capacity is 51,000 units per year, but can be increased to 102,000 units per year with an increase of $1,110,000 in annual fixed costs.
• Present variable costs amount to $120 per unit, but DimLok’s vendors are willing to offer direct materials discounts amounting to $30 per unit, beginning with unit number 71,001.
• Sales can be increased up to 122,000 units per year by committing large blocks of product to institutional buyers at a discounted unit price of $170. However, this discount applies only to sales in excess of 51,000 units per year.

Donna believes that these projections are reliable and is now trying to determine what DimLok must do to meet the profit objectives assigned by RayLok’s board of directors.

Required:

1. Determine the dollar amount of DimLok’s present annual fixed costs per year.

2. Determine the number of units that DimLok must sell to achieve both profit objectives. Be sure to consider all constraints in determining your answer.

3. Without regard to your answer in requirement 2, assume that Donna decides to sell 51,000 units at $200 per unit and 79,750 units at $170 per unit.

(a) Prepare a budgeted income statement (contribution format) for DimLok showing budgeted operating income.

(b) Would this projected operating income meet the stated profit objectives?

Answer 1

1) we have to determine the dollar amount of DimLok’s present annual fixed costs per year.

Profit target based on 25% of annual fixed costs=$910,000

The dollar value of dimlok's present annual fixed costs is,

Total fixed costs=910000/25%=910000/0.25=$3,640,000 .

2)we have to determine the number of units that DimLok must sell to achieve both profit objectives

Now, contribution per unit below the51,001 unit level,

=$200 selling price-($120 variable cost per unit +$30 profit per unit)=$50 contribution per unit upto 51,000

calculate the number of units to acheive the desired profit objectives

=(fixed charges+desired profit)/contribution per unit=($3,640,000+$910000)/$50=$91,000

The contribution for production in the 51,00, tob71,001. units range =$170 selling price-($120+$30)

=$20 contribution per unit.

Now, Calculate the number of units to acheive overall profit objectives,

=(Fixed charges+Desired profit)= contribution

=( $1,110,000 + $1,110,000 +$3,640,000)=($50*51000)+($120*(102000-71000))+$50(X-51000)=$42,800

3a)We have to Prepare a budgeted income statement (contribution format) for DimLok showing budgeted operating income.

Dimlok division
Pro forma income statement
Revenue
51,000 *200	10,200,000
79750*$170	13,557,500	23,757,500
Variable costs
71,000*120	8,520,000
5100*80	408,000	8,928,000
contribution		14,829,500
Fixed costs		4,750,000
Operating income		10,079,500

B) the profit objects =contribution- fixed costs=14,829,500-4,750,000=$10,079,500