Question

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

Sales (15,000 units × $30 per unit)	$	450,000
Variable expenses		315,000
Contribution margin		135,000
Fixed expenses		90,000
Net operating income	$	45,000

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

Answer 1

Solution:

Part 1 --- Contribution Format Income Statement

Contribution Format Income Statement
	Present		Proposed
	Total	Per Unit	Total	Per Unit
Sales	$450,000	$30	$450,000	$30
Less: Variable Expenses	$315,000	$21	$180,000	$12 ($21-9)
Contribution Margin	$135,000	$9	$270,000	$18
Less: Fixed Expenses	$90,000		$225,000
Net Operating Income	$45,000		$45,000

Part 2 –

a) Degree of Operating Leverage	Present	Proposed
Contribution Margin	$135,000	$270,000
Net Operating Income	$45,000	$45,000
Degree of Operating Leverage (Contribution Margin / Net Operating Income)	3.00	6.00
b) Break Even Point in dollar sales
Fixed Expenses	$90,000	$225,000
Contribution Margin Ratio	30% (CM 135,000 / Sales 450,000 x 100)	60% (CM 270,000 / Sales 450,000 x 100)
Break Even Point in dollar sales (Fixed Expenses / CM Ratio)	$300,000	$375,000
C) Margin of Safety in dollars
Sales	$450,000	$450,000
Break Even Sales in dollars	$300,000	$375,000
Margin of Safety in dollars (Sales - BE Sales)	$150,000	$75,000
Margin of Safety in Percentage (Margin of Safety in dollar / Sales x 100)	33.33%	16.67%

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Pls ask separate question for remaining parts.