For nearly 20 years Custom Coatings has provided painting and galvanizing servic

Question

For nearly 20 years Custom Coatings has provided painting and galvanizing services for manufacturers in its region. Manufacturers of various metal products have relied on the quality and quick turnaround time provided by Custom Coatings and its 20 skilled employees. During the last year, as a result of a sharp upturn in the economy, the company's sales have increased by 30% relative to the previous year. The company has not been able to increase its capacity fast enough, so Custom Coatings has had to turn work away because it cannot keep up with customer requests. Top management is considering the purchase of a sophisticated robotic painting booth. The booth would represent a considerable move in the direction of automation versus manual labor. If Custom Coatings purchases the booth, it would most likely lay off 15 of its skilled painters. To analyze the decision, the company compiled production information from the most recent year and then prepared a parallel compilation assuming that the company would purchase the new equipment and lay off the workers. Those data are shown below. As you can see, the company projects that during the last year it would have been far more profitable if it had used the automated approach. Current Approach Automated Approach Sales $2,000,000 $2,000,000 Variable costs 1,200,000 400,000 Contribution margin 800,000 1,600,000 Fixed costs 200,000 600,000 Net income $ 600,000 $1,000,000 E. At what level of sales would the company

Explanation / Answer

Custom Coatings, a painting company, is growing rapidly and needs help determining how to handle this accelerating growth. The company has experienced an unexpected increase in sales by 30% when compared to the previous year. Currently, the company relies on manual labor to complete their work for customers, but management is considering an investment in automated equipment to increase their output capacity. A robotic painting booth would be implemented as an alternative to skilled labor, allowing Custom Coatings to decrease its overall workforce. The following analysis will outline the potential outcomes of this invest by using cost volume profit calculations. These calculations will help management make a well-educated decision regarding the purchase of the robotic painting booth. Contribution Margin Ratio: The first step in the analysis is to calculate the contribution margin under each possible scenario. Contribution margin is important because it shows management how much revenue is left over after variable costs have been deducted. This allows managers to see how large of an impact variable costs will make when the robotic painting booth is implemented. When calculated as a ratio, the company can easily apply this analysis over an infinite number of revenue predictions The contribution margin calculations for Custom Coatings are as follows: Current approach: $800,000

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