The Unruh Company reports the following results for the month of November: Sales

Question

The Unruh Company reports the following results for the month of November:

Sales (10,000 units) $600,000
Variable costs 420,000
Contribution margin 180,000
Fixed costs 110,000
Net income $ 70,000

Management is considering the following independent courses of action to increase net income.
1. Increase selling price by 10% with no change in total variable costs.
2. Reduce variable costs to 60% of sales.
3. Reduce fixed costs by $30,000.

Instructions:
If maximizing net income is the objective, which is the best course of action? Show all of your computations.

Explanation / Answer

(1) Increase selling price by 10%
Original selling price = $600,000/10000 units = $60/unit
New Selling price = $60 x 1.1 = $66
Assume sales volume is still 10,000 units, sales revenue will be $66 x 10,000 = $660,000
This will increase net income from $70,000 to (70,000 + 660000 - 600000) = $130,000

(2) Reduce variable costs to 60% of sales
60% of sales = 600000 x 0.6= $360000
Thus variable cost drops from 420,000 to $360,000 (Total $60,000)
A drop in variable cost will increase the net income from $70000 to (70000 + 60000) = $130,000

(3) Reduced fixed cost by $30,000
This will increase net income by $30,000 to (70000 + 30000) = $100,000


Choice 1 and Choice 2 has the same net income ($130,000). However, we can argue that an increase in selling price is likely to reduce the sales volume. Thus, overall net income will decreases.

Thus, probably Choice 2 will be the best course of action

Hope this helps!

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