Question

Exercise 20-3 Barnes Company reports the following operating results for the month of August: sales $300,000 (units 5,000); variable costs $217,000; and fixed costs $70,000. Management is considering the following independent courses of action to increase net income. Compute the net income to be earned under each alternative. 1. Increase selling price by 10% with no change in total variable costs or sales volume. Net income 2. Reduce variable costs to 55% of sales. Net income 3. Reduce fixed costs by $18,000. Net income Which course of action will produce the highest net income?

Answer 1

Solution

If seen initially, the net income should be,

Sales (5000 x $60)	$   3,00,000.00
Less: Variable Costs	$ -2,17,000.00
Contribution	$       83,000.00
Less: Fixed Costs	$     -70,000.00
Net Income	$       13,000.00

(1) If selling price increased by 10% without changing the total variable cost or sales volume, the per unit sales price should be = $60 x 110% = $66. Effect in net income should be as follows,

Sales (5000 x $66)	$   3,30,000.00
Less: Variable Costs	$ -2,17,000.00
Contribution	$   1,13,000.00
Less: Fixed Costs	$     -70,000.00
Net Income	$       43,000.00

(2) If reducing variable costs to 55% of sales, i.e. Variable Costs = $300,000 x 55% = $165,000, the net income should be,

Sales (5000 x $60)	$   3,00,000.00
Less: Variable Costs	$ -1,65,000.00
Contribution	$   1,35,000.00
Less: Fixed Costs	$     -70,000.00
Net Income	$       65,000.00

(3) If reduce fixed costs by $18,000, i.e. Fixed Costs = $70,000 - $18,000 = $52,000

Sales (5000 x $60)	$   3,00,000.00
Less: Variable Costs	$ -2,17,000.00
Contribution	$       83,000.00
Less: Fixed Costs	$     -52,000.00
Net Income	$       31,000.00

(4) Therefore, on the basis of the above calculations it can be concluded that if Alternative (2) is followed, the company could produce highest net income.