Due to the sluggish economy, the Iguodala Company has experienced some difficult
ID: 2525571 • Letter: D
Question
Due to the sluggish economy, the Iguodala Company has experienced some difficulty in selling its bicycles. The following data relate to the current year:
a. Compute Iguodala’s annual breakeven point, in both units and dollars. Also, compute the contribution margin ratio.
b. The manager believes that a $40,000 increase in advertising would result in a $120,000 increase in annual sales. If the manager is right, what will be the net effect on the company's operating income?
c. Refer to the original data. The vice-president in charge of sales is certain that a 10% reduction in selling price in combination with a $30,000 increase in advertising will cause sales volume to increases by 50%. What effect would this strategy have on operating income of the company?
d. Refer to the original data. In the following year, Iguodala saved $5 of total variable costs per bicycle by buying parts from a different manufacturer. However, Iguodala’s rent and insurance increased by $5,600. The store sold 11,000 bikes. What was its operating income for the year?
Sales (9,000 Units @ $100/unit) $900,000 Less variable costs (9,000 @ $60/unit) $540,000 Contribution margin $360,000 Less fixed costs $400,000 Net operating loss ($40,000)Explanation / Answer
Iguodala Company
Contribution margin ratio –
Contribution margin ratio = contribution margin/sales
Contribution margin = $360,000
Sales = $900,000
Contribution margin ratio = $360,000/$900,000 = 40%
Break-even point:
Contribution margin per unit = $360,000/9,000 = $40 per unit
Fixed cost = $400,000
Break-even point in unit sales = $400,000/$40 = 10,000 units
Break-even point:
In dollar sales = fixed cost/Contribution margin ratio
Fixed cost = $400,000
Contribution margin ratio = 40%
Break-even point in dollar sales = $400,000/40% = $1,000,000
Increase in sales = $120,000
Incremental increase in contribution margin = $120,000 x 40% = $480,000
Less: Additional fixed cost = $40,000
Net operating income = $440,000
Original net operating income/(Loss) = -$40,000
Hence increase = $440,000 – ($40,000)= $480,000
Hence, Net income increases with increase in advertising expense and sales.
= $100 -10% = $90
Advertising expense = $30,000
Increase in sales volume = 50% = 9,000 + 50% = $13,500
Revised contribution margin per unit = $90 - $60 = $30 per unit
Revised fixed expenses = $400,000 + $30,000 = $430,000
Contribution margin income statement with revised changes:
Sales
13,500 units at $90 per unit
$1,215,000
Variable costs
at $60 per unit
$810,000
Contribution margin
$405,000
Fixed expenses
$430,000
Net income/(loss)
($25,000)
Hence, the effect of the proposed changes on net income is that the changes tend to lower net income.
Increase in rent and insurance = $5,600
Sales = 11,000 bikes
Operating income
Sales
11,000 units x $100
$1,100,000
Variable costs
$55
$605,000
Contribution margin
$495,000
Fixed expenses
$400,000
Add: rent and insurance
$5,600
$405,600
Net Income
$89,400
Hence the operating income when the variable cost reduces by $5 per unit and fixed cost increase by $5,600 would be $89,400.
The company reports net income of $89,400 for all sales above the break-even level of 10000 units.
Sales
13,500 units at $90 per unit
$1,215,000
Variable costs
at $60 per unit
$810,000
Contribution margin
$405,000
Fixed expenses
$430,000
Net income/(loss)
($25,000)