Question

Could you please post the solution to Exercise 20.8 in Financial & Managerial Accounting 18th Edition by Jan Williams?

EXERCISE 20.8 Using Cost-Volume-Profit Formulas Arrow Products typically earns a contribution margin ratio of 25 percent and has current fixed costs of $80,000. Arrow’s general manager is considering spending an additional $20,000 to do one of the following. Start a new ad campaign that is expected to increase sales revenue by 5 percent. License a new computerized ordering system that is expected to increase Arrow’s contribution margin ratio to 30 percent. Sales revenue for the coming year was initially forecast to equal $1,200,000 (that is, without implementing either of the given options). For each option, how much will projected operating income increase or decrease relative to initial predictions? By what percentage would sales revenue need to increase to make the ad campaign as attractive as the ordering system?

Answer 1

a) For each option how much will projected operating income increase or decrease relative to initial predications?
Initial predictions: 1,200,000*.25 = $300,000

300,000 – 80,000 = $220,000.
Option 1: $1,260,000*.25 = 315,000
$315,000 – $100,000 = $215,000, which is a decrease of $5,000 relative the initial prediction of $220,000.
Option 2: $1,200,000*30 = $360,000
$360,000 – $100,000 = $260,000, which is an increase of $40,000 relative to the initial prediction ($220,000).
b) By what percentage would sales revenue need to increase to make the ad campaign as attractive as the ordering system?

$360,000/.25 = $1,440,000
(1,440,000 – 1,200,000)/1,200,000 = .20 or 20%