Precision Systems manufactures CD burners and currently sells 18,500 units annually to producers of laptop computers. Jay Wilson, president of the company, anticipates a 15 percent increase in the cost per unit of direct labor on January 1 of next year. He expects all other costs and expenses to remain unchanged. Wilson has asked you to assist him in developing the information he needs to formulate a reasonable product strategy for next year. You are satisfied that volume is the primary factor affecting costs and expenses and have separated the semivariable costs into their fixed and variable segments. Beginning and ending inventories remain at a level of 1,000 units. Current plant capacity is 20,000 units.

The following are the current-year data assembled for your analysis. Sales price per unit $ 100 Variable costs per unit: Direct materials $ 10 Direct labor 20 Manufacturing overhead and selling and administrative expenses 30 60 Contribution margin per unit (40%) $ 40 Fixed costs $ 390,000

Required:

a. What increase in the selling price is necessary to cover the 15 percent increase in direct labor cost and still maintain the current contribution margin ratio of 40 percent?

b. How many units must be sold to maintain the current operating income of $350,000 if the sales price remains at $100 and the 15 percent wage increase goes into effect? (Hint: First compute the unit contribution margin.)

c. Wilson believes that an additional $700,000 of machinery (to be depreciated at 20 percent annually) will increase present capacity (20,000 units) by 25 percent. If all units produced can be sold at the present price of $100 per unit and the wage increase goes into effect, how would the estimated operating income before capacity is increased compare with the estimated operating income after capacity is increased? Prepare schedules of estimated operating income at full capacity before and after the expansion.