Answer:
a. What increase in the selling price is necessary to cover the 15 percent increase in direct labor cost and still maintain the current contribution margin ratio of 40 percent?
estimated production costs per unit:
direct materials $10
direct labor $23
overhead $30
total $63
if we want contribution margin to remain at 40%, then selling price = $63 / (1 - 40%) = <u>$105</u>
to verify our answer, contribution margin = $105 - $63 = $42 / $105 = 40%
b. How many units must be sold to maintain the current operating income of $350,000 if the sales price remains at $100 and the 15 percent wage increase goes into effect?
if sales price doesn't change, then contribution margin = $37 (not $40)
units sold to keep profit at $350,000 = ($350,000 + $390,000) / $37 = <u>20,000 units per year</u>
c. Wilson believes that an additional $700,000 of machinery (to be depreciated at 20 percent annually) will increase present capacity (20,000 units) by 25 percent. If all units produced can be sold at the present price of $100 per unit and the wage increase goes into effect, how would the estimated operating income before capacity is increased compare with the estimated operating income after capacity is increased? Prepare schedules of estimated operating income at full capacity before and after the expansion.
working at full capacity, sales price $100 (unchanged) and direct labor costs increasing by 15%
capacity 20,000 capacity 25,000
sales revenue $2,000,000 $2,500,000
direct labor $460,000 $575,000
direct materials $200,000 $250,000
overhead $600,000 $750,000
fixed costs <u> $390,000 </u> <u> $670,000 </u>
operating revenue $350,000 $255,000
The expansion will result in lower operating profits ($95,000 less) so it should be discarded.
