INCOM Company The decline in our profits has become intolerable. The severe pric
ID: 2602479 • Letter: I
Question
INCOM Company The decline in our profits has become intolerable. The severe price cutting in pumps has dropped our pre-tax margm to less than 3% ar below our listorical 10% margins. Fortunately, our competitors are overlook! g the opportinities for profit 111 low controllers. Our rece t 10% price increase in that line has bee implemented without losing any business Robert Johnson, president of the INCOM Company, was discussing operating results in the latest month with Ahmed Khan, his controller, and John Scott, his manufacturing manager. The meeting among the three was taking place in an atmosphere tinged with apprehension because competitors had been reducing prices on pumps, INCOM's major product line. Since pumps were a commodity product, Johnson had seen no alternative but to match the reduced prices to maintain volume. But the price cuts had led to declining company profits, especially in the pump line (summary operating results for the previous month, March 2016, are shown in Exhibits 1 and 2) INCOM supplied products to manufacturers of water purification equipment. The company had started with a unique design for valves that it could produce to tolerances that were better than any in the industry Johnson quickly established a loyal customer base because of the high quality of its manufactured valves He and Scott realized that INCOM's existing labor skills and machining equipment could also be used to produce pumps and flow controllers, products that were also purchased by its customers.They soon established a major presence in the high-volume pump product line and the more customized flow controller ineExplanation / Answer
Requirement
Income statement for March 2016
Sales
Direct Labour expense
Direct materials expense
Manufacturing overhead
Material
(Assuming the ratio of products is close to that of March 2016)
INCOM Company Inc.Requirement
1 Assumption Prices of raw material will increase by 5% of 458000Income statement for March 2016
Sales
2152500Direct Labour expense
271250Direct materials expense
480900Manufacturing overhead
Machine related expenses 336000 Setup Labour 40000 Receiving and production control 180000 Engineering 100000 Packaging and shipping 150000 806000 Gross margin 594350 28% General selling & admin exp 559650 Operating income (pre-tax) 34700 2% Required increase in sales to keep existing margin of 3% Calculation When sales are 2152500 The existing profit nargin is 3% 57600 If sales are The required profit margin 57600 will result if sales are 2880000 the existing profit margin will 2% 57600.00 be maintained I suggest that the company increase all selling prices to keep the existing profit margin. 2 Contribution margin income statement for March 2016 Sales 2152500 less variable costs: Labour 271250 Material 480900 Overhead: Variable Machine related expenses 268800 Setup Labour 0 Receiving and production control 162000 Engineering 0 Packaging and shipping 75000 General selling & admin exp 55965 Total variable overheads 561765 Total variable costs 1313915 Contribution margin 838585 3 Income statement for April 2016 Assumptions Selling price Valves 7600 86 653600 Pumps 12000 87 1044000 Flow controllers 4200 105 441000 Sales 2138600 Valves 7600 Pumps 12000 Flow controllers 4200 Variable costsMaterial
Valves 16 121600 Pumps 20 240000 Flow controllers 22 92400 454000 Labour cost Valves 10 76000 Pumps 12.5 150000 Flow controllers 10 42000 268000 Contribution margin 1416600 4 Break even point (in terms of products and sales)(Assuming the ratio of products is close to that of March 2016)
4 Break even point (in terms of products and sales) (Assuming the ratio of products is close to that of March 2016) Contribution margin 1416600 Fixed costs Setup Labour 40000 Engineering 100000 140000 The break even will occur when the contribution margin is 140000 5 Assuming an increase of direct material cost of 5% The break even would occur when the contribution margin is 147000