Problem 5-29 Changes in Cost Structure; Break-Even Analysis; Operating Leverage; Margin of Safety [LO5-4, LO5-5, LO5-7, LO5-8]

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

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 $9 per unit. However, fixed expenses would increase to a total of $225,000 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 $180,000; and its net operating income would increase by 20%. Compute the company's break-even point in dollar sales under the new marketing strategy.

Problem 5-29 Changes in Cost Structure; Break-Even Analysis; Operating Leverage; Margin of Safety [LO5-4, LO5-5, LO5-7, LO5-8]

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

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 $8.70 per unit. However, fixed expenses would increase to a total of $767,340 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 $359,513; and its net operating income would increase by 20%. Compute the company's break-even point in dollar sales under the new marketing strategy.

You have been recruited by a former classmate, Susanna Wu, to join the finance team of a company that she founded recently. The company produces a unique product line of hypoallergenic cosmetics and relies for its success on an aggressive marketing program. The company is in a start-up phase and therefore has no significant history of expenses and revenues upon which to rely for budgeting and planning purposes. Given the restriction on available funds (most of the available capital has been used for new-product development and to recruit a management team), the control of costs, including marketing costs, is thought by the management team to be essential for the short-term viability of the company. You have held a number of intensive discussions with Susanna and John Thompson, director of marketing for the firm. They have asked you to prepare an estimated budget for marketing expenses for a month of operations. You are provided with the following data, which represent average actual monthly costs over the past three months: CostAmountSales commissions$125,000Sales staff salaries42,500Telephone and mailing40,500Rental—office building22,500Gas (utilities)12,500Delivery charges71,500Depreciation—office furniture9,500Marketing consultants25,500 Your discussions with John and Susanna indicate the following assumptions and anticipated changes regarding monthly marketing expenses for the coming year: Sales volume, because of aggressive marketing, should increase by 16%.To meet competitive pressures, sales prices are expected to decrease by 8%.Sales commissions are based on a percentage of sales revenue.Sales staff salaries, because of a new hire, will increase by 16%, regardless of sales volume.Because of recent industrywide factors, rates for telephone and mailing costs, as well as delivery charges, are expected to increase by 6%. However, both of these categories of costs are variable with sales volume.Rent on the office building is based on a 2-year lease, with 21 months remaining on the original lease.Gas utility costs are largely independent of changes in sales volume. However, because of industrywide disruptions in supply, these costs are expected to increase by 16%, regardless of changes in sales volume.Depreciation on the office furniture used by members of the sales staff should increase because of new equipment that will be acquired. The planned cost for this equipment is $14,400, which will be depreciated using the straight-line (SL) method, with no salvage value, over a 4-year useful life.Because of competitive pressure, the company plans to increase the cost of marketing consultants by $7,500 per month.

Required:

1. Based on the preceding information, what is the percentage change, by line item and in total, for items in your budget?

2. The management team is worried about the short-term financial position of the new company. Given the strain on available cash, the president has expressed a desire to keep marketing expenses over the next few months to a maximum of $363,000. Discussions with the marketing department indicate that telephone and mailing costs are the only category, in the short run, that can reasonably bear the planned-for reduction in marketing costs. The budget you have prepared includes an assumed 6% increase in telephone and mailing costs. What must this percentage change (positive or negative) be in order to achieve targeted monthly marketing costs? (Hint: The Goal Seek function in Excel can be used to calculate the percentage changes, which can be found under Data, then What-If Analysis.)

Please also go over the Excel file attached to this assignment in order to familiarize yourself with the different ways Excel can be used to solve Time Value of Money/Dividend Discount Model problems. There are three worksheets in the Excel file. This Excel file with examples is just that: a file to show you some examples of using Excel to solve TVM /DDM problems. Do not confuse this posted Excel file with the separate Excel file you need to create and submit with the answers to this week's homework questions. You should examine the formulas in the posted Excel file and use them as a guide when you create your new Excel file for submission. You may even copy the Excel worksheets from the sample file and then modify it to solve the homework problems.

1. Calculate the value of a preferred stock with a red annual dividend of $2.45, assuming
a discount rate of 9.5%. Solve the problem two different ways: rst by using the
algebraic formula for a constant dividend preferred stock, then by using the built-in
Excel function PV. hint: Use the Preferred Stock example in the posted DDM Excel
Examples le as a guide. Feel free to copy the worksheet and make the minor necessary
changes to answer this question.

2. Calculate the value of a stock with an expected annual dividend of $2.00 next year and
estimated annual dividend growth of 2% per year indenitely. Assume a discount rate
of 8%. Solve the problem two diferent ways: rst by using the algebraic formula for
the Gordon Growth Model, then by using Excel to calculate and sum the dividends
and their respective present values for the next 150 years. hint: Use the PV Const
Growth Dividend example in the posted DDM Excel Examples le as a guide. Feel free
to copy the worksheet and make the minor necessary changes to answer this question.

3. Calculate the value of a stock with the following expectations for dividend payments:
$1.75 in Year 1, $2.00 in Year 2, and then annual dividend growth of 1.5% per year
indenitely. Assume a discount rate of 9%. Solve the problem two different ways: rst
by using the algebraic formula for the Gordon Growth Model combined with PV of
uneven dividend payments, then by using Excel to calculate and sum the dividends
and their respective present values for the next 150 years. hint: Use the Uneven,
then Const. Growth Div example in the posted DDM Excel Examples le as a guide.
Feel free to copy the worksheet and make the minor necessary changes to answer this
question.

4. Calculate the value of a stock with the following expectations for dividend payments:
$1.75 in Years 1, 2 and 3, and then annual dividend growth of 1.5% per year indenitely.
Assume a discount rate of 9%. Solve the problem two different ways: rst by using the
algebraic formula for the Gordon Growth Model combined with PV of uneven dividend
payments, then by using Excel to calculate and sum the dividends and their respective
present values for the next 150 years. hint: Use the Uneven, then Const. Growth
Div example in the posted DDM Excel Examples le as a guide. Feel free to copy the
worksheet and make the minor necessary changes to answer this question.

Mazeppa Corporation sells relays at a selling price of $28 per unit. The company's cost per unit, based on full capacity of 160,000 units, is as follows: Direct materials $ 8 Direct labor 6 Overhead (2/3 of which is variable) 9 Mazeppa has been approached by a distributor in Montana offering to buy a special order consisting of 30,000 relays. Mazeppa has the capacity to fill the order. However, it will incur an additional shipping cost of $2 for each relay it sells to the distributor.

a-1. Assume that Mazeppa is currently operating at a level of 100,000 units. Show the calculation for the unit price to charge the distributor which will generate an increase in operating income of $3 per unit?

a-2. What is your interpretation of the changes to the contribution margin per unit and the operating income on account of the increase in selling price?

b-1. Assume that Mazeppa is currently operating at full capacity. Show the calculation for the unit price to charge the distributor which will generate an increase in operating income of $60,000 more than it would be without accepting the special order?

b-2. What is your interpretation of the changes to the contribution margin per unit and the operating income on account of the unit price charged to the distributor?

Assume that Mazeppa is currently operating at a level of 100,000 units. Show the calculation for the unit price to charge the distributor which will generate an increase in operating income of $3 per unit?

What is your interpretation of the changes to the contribution margin per unit and the operating income on account of the unit price charged to the distributor?

Assume that Mazeppa is currently operating at full capacity. Show the calculation for the unit price to charge the distributor which will generate an increase in operating income of $60,000 more than it would be without accepting the special order?

What is your interpretation of the changes to the contribution margin per unit and the operating income on account of the unit price charged to the distributor?

A bill of materials is used in manufacturing and production to show all of the parts and materials required to manufacture a specific item or for the subassembly of a finished product, such as a motorcycle. The information in the bill of materials is useful for determining product costs, coordinating orders, and managing inventory. It can also show how product costs will be affected by price changes in components or raw materials. This project provides you with an opportunity to use spreadsheet software to perform a sensitivity analysis showing the impact of various prices for component parts on the total costs of a dirt bike. The bill of materials for this project has been simplified for instructional purposes.

Dirt Bikes’s management has asked you to explore the impact of changes in some of its parts components on production costs. Review the spreadsheet file containing bill of materials information for the brake system for Dirt Bikes’s Moto 300 model, which can be found on the Laudon Web site for this chapter. The completed bill of materials contains the description of the component, the identification number of each component, the supplier (source) of the component, the unit cost of each component, the quantity of each component needed to make each finished brake system, the extended cost of each component, and the total materials cost. The extended cost is calculated by multiplying the quantity of each component needed to produce the finished brake system by the unit cost. The prices of components are constantly changing, and you will need to develop a spreadsheet application that can show management the impact of such price changes on the cost to produce each brake system and on total production costs for the Moto 300 model.

Complete the bill of materials by calculating the extended cost of each component and the total materials cost for each brake system.

Develop a sensitivity analysis (refer to pages 472-473) to show the impact on total brake system materials costs if the front brake calipers unit cost ranges from $103 to $107 and if the brake pipe unit cost ranges from $27 to $30.

The brake system represents 30 percent of the total materials cost for one Moto 300 motorcycle. Use sensitivity analysis again to show the impact of the changes in front brake caliper unit costs and brake pipe unit costs described previously on total materials costs for this motorcycle model.

You are provided with the files "Song.java" and "SongList.java". You are required complete the methods in the latter file to implement the sorted circular linked list. The list is sorted according to the title of each song in alphabetical order. You need to write these methods: add(String artist, String title) – This method takes an artist and a title and adds a Song node with these values into the list. The list must still be sorted in ascending order by song title. You do not need to handle duplicates – you can assume that we never insert the same song for more than once. This method takes an artist and a title and remove a Song node that matches the artist and the title from the list. If remove is successful, return true. If no such node exists, return false. buildList(String artist) – This method takes an artist and searches in the list for all the song nodes associated with this artist. It then adds all these nodes into a new sorted circular linked list and returns it as a SongList object. Do not alter the original song list in this method.

public class Song
{
// instance variables
private String m_artist;
private String m_title;
private Song m_link;

// constructor
public Song(String artist, String title)
{
m_artist = artist;
m_title = title;
m_link = null;
}

// getters and setters
public void setArtist(String artist)
{
m_artist = artist;
}

public String getArtist()
{
return m_artist;
}

public void setTitle(String title)
{
m_title = title;
}

public String getTitle()
{
return m_title;
}
  
public void setLink(Song link)
{
m_link = link;
}

public Song getLink()
{
return m_link;
}
}

public class SongList
{
// instance variables
private Song m_last;
private int m_numElements;

// constructor
// Do not make any changes to this method!
public SongList()
{
m_last = null;
m_numElements = 0;
}

// check whether the list is empty
// Do not make any changes to this method!
boolean isEmpty()
{
if (m_last == null)
return true;
else
return false;
}

// return the size of the list (# of Song nodes)
// Do not make any changes to this method!
public int size()
{
return m_numElements;
}

// add a new Song to the circular linked list with the given artist and
// title, keeping the list sorted by *song title*.
public void add(String artist, String title)
{
// TODO: implement this method
}

// remove a Song associated with the given artist and title from the list,
// keeping the list sorted by *song title*.
public boolean remove(String artist, String title)
{
find(artist);
if(found)
{
if (Songlist == Songlist.getLink())
list = null;
else if (previous.getLink() == Songlist)
previous.setLink(m_last.getLink());
numElements--;
}
  
return found;

}
  
  
// build and return a circular linked list that contains all songs from the
// given artist
public SongList buildList(String artist)
{
// TODO: implement this method
}
  
// return a string representation of the list
// Do not make any changes to this method!
public String toString()
{   
String listContent = "";
Song current = m_last;
  
if (m_last != null)
do
{
current = current.getLink();
listContent += " [" + current.getArtist() + " - " + current.getTitle() + "]\n";

} while (current != m_last);

return listContent;
}
}

Innocence Project Written Assignment

Provide answers to the following questions. Remember, to receive full credit you must answer each of the QUESTIONS OF THE CASE THAT FOLLOWS , along with the summary questions.

Case Name (1/2 Page): ___________________

1-In ONE complete sentence describe the crime that occurred in your own words, informed by the Innocence Project website or as found in your web-based research.

2-What is the status of the case? Has the person convicted of the crime been exonerated and if so, by what means?

3-Was human memory accurate or inaccurate in this case?

4-Be sure to describe evidence that you believe supports your position.

Summary Questions (1/2 Page):

1-Identify the goals of the Innocence Project.

2-Choose ONE of the cases you’ve already summarized. What features of the situation (i.e., memory for crime, investigation techniques used, reliance on psychological evidence or not) might have impacted the outcome of that case?

3-Be sure to reference information you learned in the lab.

4-Now, look back to the Eyewitness Memory Survey you took during lab. After learning more about false memories and the effect they can have in real-life situations, did any of your answers changes? Why or why not?

Nathan Brown was exonerated on June 25th, 2014 after serving nearly 17 years for an attempted rape that he did not commit. Brown was 23 years old when he was convicted, and was eventually exonerated on the basis of DNA evidence which excluded him from the perpetrator’s profile. The Crime In the early-morning hours of August 7th, 1997, a 40-year old white woman was walking through the courtyard of her apartment building when she was attacked from behind and thrown to the ground. The assailant bit the victim’s neck, ripped her dress open and took her purse before she was able to fend him off by striking him with her high heels, which she was carrying. The victim saw her assailant flee on a bike shortly after she reported the incident to a police officer who had been called by neighbors who heard the victim’s screams. Investigation and Trial The victim told police that she had been attacked by a black man who was wearing black shorts and no shirt. She also said the man had a very strong body odor. Although the victim believed her attacker lived outside of the apartment complex, a security guard for the complex directed police to Nathan Brown—one of the few black people living in the apartment complex. Police knocked on Brown’s door just minutes after the crime. He was in his bedroom wearing pajamas, rocking his young daughter to sleep. The officers conducted what is called a one-on-one “show-up,” a highly-suggestive identification procedure in which a single suspect is presented to the eyewitness at either the site of the arrest or near the site of the crime. Brown was told to get dressed. He changed out of his pajamas into black shorts and was taken outside to the victim who was waiting in a patrol car. Brown had no shirt on. The victim was asked to get out to take a closer look and to smell Brown, at which point she identified him as her assailant. Although Brown did not have strong body odor, but rather smelled of soap, she explained at trial that she believed he must have taken a shower and that meant he was her attacker. Brown went on trial on November 19, 1997. Brown’s mother retained a private lawyer to represent him. The lawyer, Frank J. Larre, met Brown for the first time on the day his trial was set to start. At trial, the victim claimed that she recalled seeing a tattoo with the letters “LLE” on the assailant’s chest. A police officer testified that the victim did not mention anything about the tattoo until after the show-up, during which Brown was shirtless, exposing his chest tattoo of the name “MICHELLE.” Brown testified in his own defense and told the jury that he was at home caring for his “fussy infant daughter” at the time of the crime. Despite the fact that four relatives who were at home with Brown that night testified as alibi witnesses, Brown was convicted in less than a day. He was sentenced to 25 years in prison without the possibility of parole for the crime of attempted aggravated rape. Post-Conviction Investigation Brown maintained his innocence throughout his 16 years in prison and contacted the Innocence Project to help prove his wrongful conviction. With the consent of the Jefferson Parish District Attorney’s Office, the Innocence Project conducted DNA testing of a stain on the shoulder of the victim’s dress where she was bitten. The stain tested positive for saliva and yielded a full male DNA profile that excluded Brown. This profile was consistent with male DNA found on three other areas of the dress, including the front where the assailant ripped it open. The profile was entered into the federal DNA database and there was a match to an offender convicted of a felony in Mississippi. The match was a black male who was 17 years old at the time of the crime and living within blocks of the apartment complex where the victim was attacked. The lack of preparation evident in Brown’s legal defense also contributed to his wrongful conviction. “Mr. Brown’s mother paid for an attorney who it appears did almost nothing to prepare for the trial,” said Emily Maw, director of the Innocence Project New Orleans. “Unfortunately we have seen that happen far too many times here in Louisiana. Of the 41 people who have been exonerated in Louisiana, more than two-thirds had less than effective defense lawyers.”

Problem-based Scenario –

Your client, Sonny Days Limited (Sonny Days) is a company involved in the manufacture and development of play equipment for parks, schools and other bodies such as local authorities, councils and community groups. Sonny Days was set up in Ireland five years ago with support from government grants for employment costs and capital equipment costs. The company’s employee numbers continue to expand from a starting base of 15 employees.

As external auditors to Sonny Days, your firm’s audit approach has been to carry out an interim audit approximately ten months into the company’s financial year; followed by the final audit, which generally commences six weeks after the year-end. As a newly appointed Audit Senior you have been given managerial responsibility for this assignment and are currently reviewing the audit papers which were prepared during the interim audit visit to Sonny Days.

You met with the Audit Manager for the interim audit and he has indicated to you that from his interim audit work on the payroll processing and accounting system, the system does not employ the full extent of controls, which are evident in other companies of similar size and complexity. He has copied for you comprehensive system notes which he prepared during the interim audit.

These notes are reproduced below:

“Sonny Days operates a number of payrolls, the largest of which is the “manufacturing” payroll which deals with approximately 40 employees. Manufacturing employees are paid a standard weekly wage for a 35-hour working week. However, overtime is worked by most employees and can significantly boost weekly earnings.

All manufacturing employees are required to account for their time on a daily basis. This process involves employees logging time spent on particular activities into keypads located throughout the factory. Production Supervisors provide hard copy information to

the Human Resources Department for those employees on leave and this is used to compare employees logged in against total manufacturing staff numbers. Any discrepancies should be followed up. However, this hasn’t been done for several months due to a backlog of work in the Human Resources Department in addition to Production Supervisors not providing the hard copy reports in a timely manner.

In addition, all employees complete time-sheets each week recording their standard and over-time hours. These are then forwarded to the Human Resources Department where they are manually entered into the payroll processing system. If a time-sheet is not received, the standard hours for the week are automatically generated by the system.

The payroll is then run and the payslips and automatically generated cheques are produced. These are given to the Production Supervisors who hold them for collection by the individual employees. The payroll system is integrated with the nominal ledger and it generates a payroll expense split into production and non production accounts in addition to a charge in the wages liability account and the creation of liabilities for net pay, statutory and voluntary deductions. The balance on the payroll liability account is expensed quarterly. There are no hard copy reports produced by the system.

The payroll programme uses both input hours and information sourced from the employees’ master file. The master file is updated regularly for new employees, changes to tax free allowances, new rates of pay, changes in voluntary deductions, etc. Changes are accumulated each week and processed by payroll department staff. Changes are stamped within the system and flagged with the Human Resources Department User I.D. and password which are common to all payroll staff. Changes are investigated if there are employee queries.

A separate payroll bank account is maintained and is funded by weekly transfers equal to total gross pay. All payroll related payments are made from this account.

Any balances outstanding on the various deduction accounts are written off as part of the process for preparing annual accounts each year. Any balance on the wages bank account is transferred back to the main bank account”.

Required:

(b) Sonny Days Ltd. maintains a separate bank account for its payroll expense. Identify and explain SIX (6) benefits that may be derived from using such a system?