Question

Data for Hermann Corporation are shown below:

	Per Unit				Percent of Sales
Selling price	$	130				100	%
Variable expenses		78				60
Contribution margin	$	52				40	%

Fixed expenses are $86,000 per month and the company is selling 2,800 units per month.

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 $6 per unit and increase unit sales by 15%

Answer 1

Calculation of net operating income under current plan :

Sales [ 2,800 units * $130 ]	$364,000
(-) Variable cost [ 2,800 units * $78 ]	( $218,400 )
Contribution margin	$145,600
(-) Fixed expenses	( $86,000 )
Net operating income	$59,600

Calculation of net operating income if the company uses higher-quality components :

Here, the variable cost per unit will increase by $6 and Sales units will increase by 15%

So, variable cost per unit = $78 + $6 = $84

Total sales units = 2,800 + [ 2,800 * 15% ] = 3,220 units

Sales [ 3,220 units * $130 ]	$418,600
(-) Variable cost [ 3,220 units * $84 ]	( $270,480 )
Contribution margin	$148,120
(-) Fixed expenses	( $86,000 )
Net operating income	$62,120

If the company uses higher-quality components, its net operating income will increase by $2,520 per month [ i.e. $62,120 - 59,600 ]