Quality Improvement and Profitability Objective

Gagnon Company reported the following sales and quality costs for the past four years. Assume that all quality costs are variable and that all changes in the quality cost ratios are due to a quality improvement program.

Year	Sales Revenues	Quality Costs as a Percent of Revenues
1	$20,000,000	25%
2	22,000,000	22
3	22,000,000	18
4	24,000,000	14

Required:

1. Compute the quality costs for all four years.

	Quality Cost
Year 1	$fill in the blank 1
Year 2	$fill in the blank 2
Year 3	$fill in the blank 3
Year 4	$fill in the blank 4

By how much did net income increase from Year 1 to Year 2 because of quality improvements? $fill in the blank 5

By how much did net income increase from Year 2 to Year 3 because of quality improvements? $fill in the blank 6

By how much did net income increase from Year 3 to Year 4 because of quality improvements? $fill in the blank 7

2. The management of Gagnon Company believes it is possible to reduce quality costs to 2.5 percent of sales. Assuming sales will continue at the Year 4 level, calculate the additional profit potential facing Gagnon. $fill in the blank 8

3. Assume that Gagnon produces one type of product, which is sold on a bid basis. In Years 1 and 2, the average bid was $400. In Year 1, total variable costs were $250 per unit. In Year 3, competition forced the bid to drop to $320.

In your calculations, round units to whole numbers.

Compute the total contribution margin in Year 3 assuming the same percentage of quality costs as in Year 1. $fill in the blank 9

Now, compute the total contribution margin in Year 3 using the actual quality costs for Year 3. $fill in the blank 10

What is the increase in profitability resulting from the quality improvements made from Year 1 to Year 3? $fill in the blank 11