Chapter 6, Problem 29P

Changes in Cost Structure; Break-Even Analysis; Operating Leverage; Margin of Safety L06−4, L06− 6, LOG−?, LO6−8

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

The industry in which Morton Company operates is quite sensitive to cyclical movements in the economy. Thus, profits vary considerably from vest 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 Show an Amount column, a Per Unit column, and a Percent column on each statement do not show percentages for the fixed expenses.
2.Refer to the income statements in (1) For the present operations and the proposed new operations, compute (a) the degree of operatingleverage, (b) the break-even point in dollar sales, and (C) the margin of safety in dollars and the margin of safely percentage.
3. Refer again to the data in (I). 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. Do you agree with the marketing manager’s proposal?