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 following:
1. Calculate the current contribution margin ratio.
2. Calculate the current net income.
3. Calculate the new contribution margin ratio.
4. Calculate the new net income.
5. Find the difference in the contribution margin ratio.
6. Find the difference in net income.
Let's go through each step in detail:
1. Calculate the current contribution margin ratio:
The contribution margin ratio is calculated by dividing the contribution margin by the selling price.
Contribution Margin = Selling Price - Variable Costs
Contribution Margin Ratio = (Contribution Margin / Selling Price) x 100
Given:
Selling Price = $26.50
Variable Costs per unit = $0.70
Contribution Margin = $26.50 - $0.70 = $25.80
Contribution Margin Ratio = ($25.80 / $26.50) x 100 = 97.17%
2. Calculate the current net income:
Net Income is calculated by subtracting total fixed costs from the total contribution margin.
Total Fixed Costs = Manufacturing Fixed Costs + Selling and Administrative Fixed Costs
Manufacturing Fixed Costs = $2,050,140
Selling and Administrative Fixed Costs = $794,950
Total Fixed Costs = $2,050,140 + $794,950 = $2,845,090
Net Income = Contribution Margin - Total Fixed Costs
Net Income = $25.80 - $2,845,090 = -$2,845,064.20 (Net loss)
3. Calculate the new contribution margin ratio:
The new contribution margin ratio is calculated by considering the effects of mass-producing the special-order sprinklers on variable costs and selling price.
New Variable Costs per unit = Existing Variable Costs per unit + Average increase in variable costs per unit = $0.70 + $0.70 = $1.40
New Selling Price per unit = Existing Selling Price per unit + Average increase in selling price per unit = $26.50 + $0.20 = $26.70
New Contribution Margin = New Selling Price - New Variable Costs
New Contribution Margin = $26.70 - $1.40 = $25.30
New Contribution Margin Ratio = (New Contribution Margin / New Selling Price) x 100
New Contribution Margin Ratio = ($25.30 / $26.70) x 100 = 94.77%
4. Calculate the new net income:
To calculate the new net income, we need to consider the increase in the number of sprinklers sold.
New Number of Sprinklers Sold = Current Number of Sprinklers Sold x (1 + Percentage increase)
Given:
Current Number of Sprinklers Sold = 491,740
Percentage Increase = 10%
New Number of Sprinklers Sold = 491,740 x (1 + 0.10) = 491,740 x 1.10 = 540,914 sprinklers (rounded down to the nearest whole number)
New Total Variable Costs = New Variable Costs per unit x New Number of Sprinklers Sold = $1.40 x 540,914 = $757,278.60
New Total Fixed Costs = Total Fixed Costs (unchanged)
New Net Income = New Contribution Margin - New Total Fixed Costs
New Net Income = ($25.30 x 540,914) - $2,845,090
5. Find the difference in the contribution margin ratio:
Difference in Contribution Margin Ratio = New Contribution Margin Ratio - Current Contribution Margin Ratio
Difference in Contribution Margin Ratio = 94.77% - 97.17% = -2.4%
6. Find the difference in net income:
Difference in Net Income = New Net Income - Current Net Income
Difference in Net Income = (New Contribution Margin x New Number of Sprinklers Sold) - ($25.80 x 491,740) (Note: We're using the current contribution margin since the number of sprinklers sold hasn't changed yet)
Now that all the calculations have been done, let's evaluate the effect of mass-producing the special-order sprinklers on the company based on the calculated data.