AE $1$: CVP Analysis

Fine Electronics is a small but growing manufacturer of electronic equipment. Below is Fine's

contribution format income statement for last year:

Fine's profitability is quite sensitive to cyclical movements in the economy. Thus, its profits

vary from year to year according to general economic conditions. The company relies heavily

on direct labour workers. Variable costs are high totalling $$21$ per unit, of which $60\%$ is direct

labour cost. Due to an increase in labour rates, the company estimates that direct labour costs

will increase by $$3$ per unit next year, thereby increasing total variable costs for next year. The

company has excess capacity and is studying ways to improve its profits for next year. Required

$($a$)$ Assume a new equipment has come onto the market that would allow Fine to automate

a portion of its operations in the next year. The new equipment would reduce estimated

variable costs per unit for next year by $50\%$ but fixed costs per year would double.

Assume selling price and sales volume remain unchanged. Prepare a contribution

format income statement for next year if the new equipment is purchased. Show an

Amount column, a Per Unit column, and a Percent column on the statement. Is the

contribution margin ratio with the new equipment higher or lower than the contribution

margin ratio without the new equipment?

$($b$)$ Refer to the contribution format income statement in $($a$)$ above. Compute the breakeven

point in dollars and the margin of safety.

$($c$)$ Refer again to the data in $($a$)$ above. Assume the company has sufficient funds to make

the purchase, what major factor would a manager of the company consider before

deciding to purchase the equipment.

$($d$)$ Refer to the original data for last year. Rather than purchase a new equipment, the

marketing manager argues that the company should change its marketing strategy.

Instead of paying sales commission to salespersons, the marketing manager proposes

to pay salespersons fixed salaries and invest heavily in advertising. The marketing

manager claims this new approach would increase unit sales by $37\mathrm{.}5\%$ without any

change in selling price; fixed costs would increase to $$$480,000$ and its net operating

income would increase by three times. Compute the new contribution margin ratio and

the breakeven point in dollar sales under the new marketing strategy.

$($e$)$ Do you agree with the marketing manager's proposal in $($d$)$ above?