Question

Quality Improvement and Profitability Objective

Gagnon Company reported the following sales and quality costs for the past four years. Assume that all quality costs are variable and that all changes in the quality cost ratios are due to a quality improvement program.

Year	Sales Revenues	Quality Costs as a Percent of Revenues
1	$8,320,000	25%
2	9,120,000	22
3	10,840,000	18
4	13,240,000	14

Required:

1. Compute the quality costs for all four years.

	Quality Cost
Year 1	$
Year 2	$
Year 3	$
Year 4	$

By how much did net income increase from Year 1 to Year 2 because of quality improvements?
$

By how much did net income increase from Year 2 to Year 3 because of quality improvements?
$

By how much did net income increase from Year 3 to Year 4 because of quality improvements?
$

2. The management of Gagnon Company believes it is possible to reduce quality costs to 2.5 percent of sales. Assuming sales will continue at the Year 4 level, calculate the additional profit potential facing Gagnon.
$

Is the expectation of improving quality and reducing costs to 2.5 percent of sales realistic?
Yes

3. Assume that Gagnon produces one type of product, which is sold on a bid basis. In Years 1 and 2, the average bid was $200. In Year 1, total variable costs were $120.00 per unit. In Year 3, competition forced the bid to drop to $160.00.
Do not round the intermediate calculations and round your final answers to the nearest dollar.

Compute the total contribution margin in Year 3 assuming the same quality costs as in Year 1.
$

Now, compute the total contribution margin in Year 3 using the actual quality costs for Year 3.
$

What is the increase in profitability resulting from the quality improvements made from Year 1 to Year 3?
$

Answer 1

a)b)c)
Quality Cost:-
Year-1:	2080000	($8320000X25%)
Year:2	2006400	($9120000*22%)
Year-3:	1951200	($10840000*18%)
Year-4:	1853600	($13240000*14%)

Net Income Increase
Year-1:	273600	(25%-22%)X$9120000
Year-2:	433600	(22%-18%)X$10840000
Year-3:	529600	(18%-14%)X$13240000

2) Profit Potential:

((0.14-0.025)X$1853600)=$213164

The 2.5% goal is the level many Quality Experts identify as the one that companies should Strive to obtain. Gagnon Company's Experience Shows that it is an acheivable goal .