PROBLEM 430 (Garrison text)

Changes in Cost Structure; Break-Even Analysis; Operating Leverage

Duchamp Companys contribution format income statement for the most recent month is given below:

Sales (30,000 units) $ 900,000

Variable expenses 630,000

Contribution margin 270,000

Fixed expenses 180,000

Operating income $ 90,000

The industry in which Duchamp Company operates is quite sensitive to cyclical movements in the economy. Thus, profits vary considerably from year to year according to general economic conditions. The company has a large amount of unused capacity and is studying ways of improving profits.

Required:

New equipment has come on the market that would allow Duchamp Company to automate a portion of its operations. Variable costs would be reduced by $9 per unit. However, fixed costs would increase to a total of $450,000 each month. Prepare two contribution format income statements, one showing current operations and one showing how operations would appear if the new equipment is purchased.

Show an Amount column, a Per Unit column, and a Percentage column on each statement. Do not show percentages for the fixed costs. (current versus proposed)

Refer to the income statements in (1) above. For both current operations and the proposed new operations, compute

(a) the degree of operating leverage,

(b) the break-even point in dollars.

Refer again to the data in (1) above. As a manager, what factor(s) would be paramount in your mind in deciding whether to purchase the new equipment?

(You may assume that ample funds are available to make the purchase.)