Waterways is thinking of mass-producing one of its special-order sprinklers. To do so would increase variable costs for all sprinklers by an average of $0.70 per unit. The company also estimates that this change could increase the overall number of sprinklers sold by 10%, and the average sales price would increase $0.20 per unit. Waterways currently sells 491,740 sprinkler units at an average selling price of $26.50. The manufacturing costs are $6,863,512 variable and $2,050,140 fixed. Selling and administrative costs are $2,651,657 variable and $794,950 fixed.
If Waterways begins mass-producing its special-order sprinklers, how would this affect the company? Find the change in Contribution Margin Ratio and Net Income
To find the change in Contribution Margin Ratio and Net Income, we need to calculate the current and future values of these metrics by incorporating the given information.
First, let's calculate the current Contribution Margin Ratio (CMR). The CMR is the percentage of each sales dollar that contributes to covering fixed costs and generating profit.
Current CMR is calculated as follows:
CMR = (Sales - Variable Costs) / Sales
Given data:
Current Sales = 491,740 units * $26.50 per unit = $13,013,210
Current Variable Costs = $6,863,512 (Variable manufacturing costs) + $2,651,657 (Variable selling and administrative costs) = $9,515,169
CMR = ($13,013,210 - $9,515,169) / $13,013,210
CMR ≈ 0.2680 or 26.80%
Now, let's calculate the future CMR and Net Income.
Variable cost per unit after mass production = Current Variable Costs + Increased Variable Costs
Variable cost per unit after mass production = $9,515,169 + (491,740 units * $0.70 per unit)
Variable cost per unit after mass production = $9,515,169 + $344,218
Variable cost per unit after mass production = $9,859,387
Projected Sales after mass production = Current Sales * (1 + Percentage increase in sales)
Percentage increase in sales = 10%
Projected Sales after mass production = $13,013,210 * (1 + 0.10)
Projected Sales after mass production = $13,013,210 * 1.10
Projected Sales after mass production = $14,314,531
Projected average sales price per unit = Current average sales price per unit + Increased average sales price per unit
Projected average sales price per unit = $26.50 + $0.20
Projected average sales price per unit = $26.70
Projected Variable Costs = Variable cost per unit after mass production * Projected Sales after mass production
Projected Variable Costs = $9,859,387 * $14,314,531
Now, let's calculate the future CMR and Net Income:
Future CMR = (Projected Sales - Projected Variable Costs) / Projected Sales
Future CMR = ($14,314,531 - (Projected Variable Costs)) / $14,314,531
Future Net Income = (Projected Sales - Projected Variable Costs) - (Fixed Costs + Selling and Administrative Costs)
Projected Net Income = ($14,314,531 - (Projected Variable Costs)) - ($2,050,140 + $794,950)
After performing these calculations, we would have the change in Contribution Margin Ratio and Net Income.