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Problem 5-29 Changes in Cost Structure; Break-Even Analysis; Operating Leverage; Margin of Safety [LO5.4, LO5-5, LO5-7, LO5-8) Morton Company's contribution format income statement for last month is given below! $20 per unit) Soles (50,000 unit: Variable expenses Contribution margin Fixed expenses Det operating income $1,000,000 700.000 300,000 240,000 $ 60,000 The industry in which Morton 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: 1. New equipment has come onto the market that would allow Morton Company to automate a portion of its operations. Variable expenses would be reduced by $6.00 per unit. However, fixed expenses would increase to a total of $540,000 each month. Prepare two contribution format income statements, one showing present operations and one showing how operations would appear if the new equipment is purchased. 2. Refer to the income statements in (1). For the present operations and the proposed new operations, compute (a) the degree of operating leverage. (b) the break-even point in dollar sales, and (c) the margin of safety in dollars and the margin of safety percentage 3. Refer again to the data in (1). As a manager, what factor would be paramount in your mind in deciding whether to purchase the new equipment Assume that enough funds are available to make the purchase) 4. Refer to the original data. Rather than purchase new equipment, the marketing manager argues that the company's marketing strategy should be changed. Rather than pay sales commissions, which are currently included in variable expenses, the company would pay salespersons fixed salaries and would invest heavily in advertising. The marketing manager claims this new approach would increase unit sales by 30% without any change in selling price, the company's new monthly fixed expenses would be $383.000, and its net operating income would increase by 20%. Compute the company's break-even point in dollar sales under the new marketing strategy Complete this question by entering your answers in the tabs below. Required: Required 2 Required 3 Required 4

Answer 1

				50000
				Current			Proposed
1)				Amount	per unit		Amount	per unit
	Sales			1,000,000	20		1000000	20
	Variable expenses			700,000	14		400000	8
	Contribution margin			300,000	6		600000	12
	Fixed expenses			240,000			540,000
	Net operating income			60,000			60,000
2)	Degree of operating leverage =			Contibution /net income
				Current			proposed
a)	Degree of operating leverage			5			10
b)	Break even point in dollars =			(fixed cost/contribution margin per unit)*selling price per unit
				Current			proposed
	Break even point in dollars			800000			900000
c)	Margin of safety in dollars =			Actual sales -break even sales
	Margin of safety(percentage)=			Margin of safety/Actual sales
				Current			proposed
	Margin of safety			200,000			100000
	Margin of safety (percentage)			20%			10%
3)	Cyclical movements in economy
4)	Sales	(50000*130%*20)				1300000
	Fixed cost					383000
	net operating income (60000*120%)					72000
	income statement under new marketing strategty
						Amount	%
	Sales					1300000	100%
	variable cost					845000	65%
	contribution margin					455000	35%
	fixed cost					383000
	net operating incoem					72000
	Break even point in dollars =			1094286