Question

Following a strategy of product differentiation, Instruments Inc. makes a hand held calculator, II400. Instruments Inc. presents the following data for the years 1 and 2:

Year 1Year 2

Units of II400 produced and sold50,00052,500

Selling price$40$44

Direct materials (kilograms)150,000153,375

Direct materials costs per kilogram $4.00$4.40

Manufacturing capacity for II400 (units)62,50062,500

Total manufacturing conversion costs $500,000$550,000

Manufacturing conversion costs per unit of capacity $8.00 $8.80

Selling and customer-service capacity (customers)30 29

Total selling and customer-service costs $360,000$362,500

Cost/ customer of selling & customer-service capacity $12,000$12,500

Instruments Inc. produces no defective units but it wants to reduce direct materials usage per unit of II400 in year 2. Manufacturing conversion costs in each year depend on production capacity defined in terms of II400 units that can be produced. Selling and customer-service costs depend on the number of customers that the customer and service functions are designed to support. Neither conversion costs or customer-service costs are affected by changes in actual volume. Instruments Inc. has 23 customers in year 1 and 25 customers in year 2. The industry market size for hand held calculators increased 5% from year 1 to year 2. Of the $4 increase in unit selling price, $1 is due to a general increase in prices.

Required:

a.What is the operating income for Year 1?

b.What is the operating income in Year 2?

c.What is the change in operating income from Year 1 to Year 2?

d.What amount is the revenue effect of the growth component?

e.What amount is the cost effect of the growth component?

f.What is the net effect on operating income as a result of the growth component?

g.What amount is the revenue effect of the price-recovery component?

h.What amount is the cost effect of the price-recovery component?

i.What is the net change in operating income as a result of the price-recovery component?

j.What is the net effect on operating income as a result of the productivity component?

k.The change in operating income from cost leadership.

l.The change in operating income due to industry wide effects.

m. The effect of product differentiation on operating income and a summarization of the change in operating income between Year 1 to Year 2.