Question

Required information

Exercise 6-5 Changes in Variable Costs, Fixed Costs, Selling Price, and Volume [LO6-4]

[The following information applies to the questions displayed below.]

Data for Hermann Corporation are shown below:

	Per Unit				Percent of Sales
Selling price	$	100				100	%
Variable expenses		61				61
Contribution margin	$	39				39	%

Fixed expenses are $80,000 per month and the company is selling 3,700 units per month.

Exercise 6-5 Part 1

Required:

1-a. How much will net operating income increase (decrease) per month if the monthly advertising budget increases by $8,500 and monthly sales increase by $17,500?

Net operating income

by

1-b. Should the advertising budget be increased?

Yes or No?

Exercise 6-5 Part 2

2-a. Refer to the original data. How much will net operating income increase (decrease) per month if the company uses higher-quality components that increase the variable expense by $3 per unit and increase unit sales by 15%.

Net operating income

by

2-b. Should the higher-quality components be used?

Yes or no

Answer 1

Solution part 1-a:

Increase in sales = $17,500

Increase in contribution margin = $17500*39% = $6,825

Increase (decrease) in Net operating Income = Increase in contribution margin - increase in Fixed costs

= $6825 - $8500

= ($1675)

Net Operating income decreases by $1675.

Solution part 1-b:

No, Advertising budget should not be increased as there is decrease in net operating income.

Solution part 2-a:

Current operating Income = (sales units* contribution margin per unit) - fixed Costs = (3700*$39) - $80,000 = $64,300

Now,

New unit sales = 3700*115% = 4255 units

Increase in variable expense = $3 per units

New Contribution margin per unit = $100 - ($61 +$3) = $36

New operating income = (4255*$36) - $80,000 = $73,180

Net operation income will increase by = $73180- $64300 = $8,880

Solution part 2-b:

Yes, higher-quality components be used as there is increase in net operating income.