Question

Broadening Your Perspective 20-2 (Essay) For nearly 20 years, Specialized Coatings has provided painting and galvanizing services for manufacturers in its region. Manufacturers of various metal products have relied on the quality and quick turnaround time provided by Specialized Coatings and its 20 skilled employees. During the last year as a result of a sharp upturn in the economy, the company's sales have increased by 30% relative to the previous year. The company has not been able to increase its capacity fast enough, so Specialized Coatings has had to turn work away because it cannot keep up with customer requests. Top management is considering the purchase of a sophisticated robotic painting booth. The booth would represent a considerable move in the direction of automation versus manual labor. If Specialized Coatings purchases the booth, it would most likely lay off 15 of its skilled painters. To analyze the decision, the company compiled production information from the most recent year and then prepared a parallel compilation assuming that the company would purchase the new equipment and lay off the workers. Those data are shown below. As you can see, the company projects that during the last year it would have been far more profitable if it had used the automated approach. Current Approach Approach Automated Sales Variable costs Contribution margin Fixed costs Net income $2,000,000 $2,000,000 1,000,000 1,000,000 800,000 $200,000 1,500,000 500,000 380,000 $120,000

Answer 1

What is contribution margin - it is profit before substract the fixed cost.

Contribution margin under different approach :-

Current Approach	Automated Approach
25% (500000/2000000)	50% (1000000/2000000)
Contribution margin divided by Sales	Contribution margin divided by sales

Under current approach contribution margin is low compare to automated approach. Becasue variable cost is high under current approach and in the automated approach variable cost like material and labor cost is low. So it is good opportunity for the management if they want to adopt the new technology instead of traditional technique. If company procure the specialized coating matchine they will lay off their 15 labor. So they have to procure the specialized coating machine and lay off their 15 labor so that they can achieve high contribution margin then current approach. If their contribution margin is high then their net profit is also high since fixed cost is period cost and fixed cost for that period.