Morton Company’s contribution format income statement for lastmonth is given below: Sales (45,000 units × $24 per unit) $1,080,000 Variable expenses 756,000 Contribution margin 324,000Fixed expenses 259,200 Net operating income $ 64,800 The industryin which Morton Company operates is quite sensitive to cyclicalmovements in the economy. Thus, profits vary considerably from yearto year according to general economic conditions. The company has alarge amount of unused capacity and is studying ways of improvingprofits.
Required: 1. New equipment has come onto the market that wouldallow Morton Company to automate a portion of its operations.Variable expenses would be reduced by $7.20 per unit. However,fixed expenses would increase to a total of $583,200 each month.Prepare two contribution format income statements, one showingpresent operations and one showing how operations would appear ifthe new equipment is purchased.
2. Refer to the income statements in (1). For the presentoperations and the proposed new operations, compute (a) the degreeof operating leverage, (b) the break-even point in dollar sales,and (c) the margin of safety in dollars and the margin of safetypercentage.
3. Refer again to the data in (1). As a manager, what factorwould be paramount in your mind in deciding whether to purchase thenew equipment? (Assume that enough funds are available to make thepurchase.)
4. Refer to the original data. Rather than purchase newequipment, the marketing manager argues that the company’smarketing strategy should be changed. Rather than pay salescommissions, which are currently included in variable expenses, thecompany would pay salespersons fixed salaries and would investheavily in advertising. The marketing manager claims this newapproach would increase unit sales by 30% without any change inselling price; the company’s new monthly fixed expenses would be$413,640; and its net operating income would increase by 20%.Compute the company's break-even point in dollar sales under thenew marketing strategy.
