Question

Directions for question 3 (only ones needed)

3. First, compute the total contribution margin in year 3 given the quality costs in year 1.

1. Given the information the total revenues, you must first compute the number of units sold at the new selling price.
2. Use the variable costs per unit to derive the total contribution margin.

Next, compute the total contribution margin in year 3 given the quality costs in year 3.

1. You will need to determine the quality costs per unit in year 1 using the Year 1 information about selling price and the percentage of revenues.
2. Compute the quality costs per unit in year 3 using the same information for year 3.
3. Compute the difference in quality costs, and assuming that other variable costs are constant, compute the variable costs per unit.
4. Compute the total contribution margin

Quality Improvement and Profitability Objective

Gagnon Company reported the following sales and quality costs for the past four years. Assume that all quality costs are variable and that all changes in the quality cost ratios are due to a quality improvement program.

Year	Sales Revenues	Quality Costs as a Percent of Revenues
1	$19,200,000	20%
2	20,800,000	17
3	24,320,000	13
4	25,420,000	9

Required:

1. Compute the quality costs for all four years.

	Quality Cost
Year 1	$
Year 2	$
Year 3	$
Year 4	$

By how much did net income increase from Year 1 to Year 2 because of quality improvements?
$

By how much did net income increase from Year 2 to Year 3 because of quality improvements?
$

By how much did net income increase from Year 3 to Year 4 because of quality improvements?
$

2. The management of Gagnon Company believes it is possible to reduce quality costs to 2 percent of sales. Assuming sales will continue at the Year 4 level, calculate the additional profit potential facing Gagnon.
$

Is the expectation of improving quality and reducing costs to 2 percent of sales realistic?
Yes

3. Assume that Gagnon produces one type of product, which is sold on a bid basis. In Years 1 and 2, the average bid was $400. In Year 1, total variable costs were $240.00 per unit. In Year 3, competition forced the bid to drop to $320.00.
Do not round the intermediate calculations and round your final answers to the nearest dollar.

Compute the total contribution margin in Year 3 assuming the same quality costs as in Year 1.
$

Now, compute the total contribution margin in Year 3 using the actual quality costs for Year 3.
$

What is the increase in profitability resulting from the quality improvements made from Year 1 to Year 3?
$

Answer 1

1.

Computation of quality costs and an increase in net profit:

А в D Sales Year Revenues Quality Costs as a Percent of Revenues Quality costs Incresase in net income 19200000 lo 21 32 20800000 0.17 243200000.13 25420000 0.09 =B2*C2 =B3*C3 =B4*C4 =B5*C5 =(C2-C3)*B3 =(C3-C4)*B4 =C4-C5)*B5 5 4

Results of the excel sheet are as follows:

Quality Sales Costs as a Year Revenues Percent of Revenues Quality costs Incresase in net income 1 19200000 2 20800000 324320000 4 25420000 20% 17% 13% 9% 3840000 3536000 6240001 3161600972800 2287800 1016800 170

Note: The increase in net profit is the difference in costs as it shows the additional revenue.

2.

Computation of additional profit:

Additional profit potential = Sales revenue for year 4x| Quality cost percentage (-Reduction in quality cost = $25,420,000 x(9%-2%) = $25,420,000~ 7% = $1,779,400

Yes, it is possible to achieve targets if the plans were implemented accurately.

3.

For year 3:

Computation of total contribution margin:

Net Contribution = Bid price - Variable cost = $320-$240 = $80

Computation of total contribution margin, using quality costs:

Total Contribution =Bid price-(Variable cost - Contribution)-(Quality cost x Average bid) = $320-($240 – $80)-(13%*$400) = $320 - $160 - $52 = $108

Computation of the increase in profitability from year 1 to year 3:

Increase in profitability = Total Contribution - Net Contribution = $108-$80 = $28