Answer all of the questions and show the solution   2. Frieden Company's contribution format income statement...

Solution

Frieden Company

1. Two contribution format income statements, one showing present operations and one showing how operations would appear if the new equipment is purchased:

Frieden Company
Contribution format income statements
	Present Operations	Proposed Operations
Sales	$861,000	$861,000
Variable expenses	$602,700	$344,400
Contribution Margin	$258,300	$516,600
Fixed expenses	$206,640	$464,940
Net operating income	$51,660	$51,660

1. Computation of

1. Degree of operating leverage –

Degree of operating leverage = contribution margin/net operating income

For Present operations,

DOL = $258,300/$51,660 = 5

For Proposed Operations (Purchase of new equipment),

DOL = $516,600/51,660 = 10

1. The break-even point in dollars –

Break-even point in dollars = fixed cost/contribution margin ratio

Contribution margin ratio = (contribution/sales) x 100

For Present operations,

Contribution margin ratio = 258,300/861,000 = 30%

Fixed cost = $206,640

Break-even point in dollars = 206,640/30% = $688,800

For Proposed Operations,

Contribution margin ratio = 516,600/861,000 = 60%

Fixed cost = 464,940

Break-even point in dollars = 464,940/60% = $774,900

1. Margin of safety in both dollars and percentage –

Margin of safety in dollars = actual sales – BEP sales

MOS % = margin of safety in dollars/actual sales

Present operations,

MOS = 861,000 – 688,800 = $172,200

MOS % = 172,200/861,000 = 20%

For Proposed operations,

MOS = 861,000 – 774,900

= $86,100

MOS% = 86,100/861,000 = 10%

1. Factors paramount to the decision of purchasing the new equipment:

1. The industry’s sensitivity to the cyclical movements in the economy indicates that since the purchase of new equipment would increase the CM ratio, the high economic activity would indicate strong sales and returns. However, when   the economic activity slows down and sales fall, the investment in new equipment would push losses further down.
2. Also, the company already has unused capacity and the purchase of new equipment would increase the unused capacity, which might cause a financial burden if sales are affected by the industry’s sensitivity to the slower economic activity.

1. Computation of the break-even point in dollar sales under the new marketing strategy:

Increase in unit sales = 41,000 + 50% 41,000 = 61,500

Sales price per unit = $861,000/41,000 = $21

Sales in dollars = $21 x 61,500 = $1,291,500

New monthly fixed expenses = $258,300

Increase in net operating income by 25%,

= 51,660 + 25% x 51,660 = $64,575

Hence contribution margin = 258,300 + 64,575 = $322,875

Contribution margin ratio = 322,875/1,291,500 = 25%

Break-even point in dollar sales = 258,300/25% = $1,033,200