Managerial Analysis BYP6-2 For nearly 20 years, Specialized Coatings has provide

Question

Managerial Analysis BYP6-2 For nearly 20 years, Specialized 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 Specialized 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 Special- ized Coatings has had to turn work away because it cannot keep up with customer reques 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 Specialized 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 Current Approach $2,000,000 1,500,000 500,000 380,000 S 120,000 Automated Approach $2,000,000 1,000,000 1,000,000 800,000 S 200,000 Sales Variable costs Contribution margin Fixed costs Net income Instructions (a) Compute and interpret the contribution margin ratio under each approach. (b) Compute the break-even point in sales dollars under each approach. Discuss the implications of your findings. (c) Using the current level of sales, compute the margin of safety ratio under each approach and interpret your findings. (d) Determine the degree of operating leverage for each approach at current sales levels. How much would the company's net income decline under each approach with a 10% decline in sales? (e) At what level of sales would the company's net income be the same under either approach? (D) Discuss the issues that the company must consider in making this decision.

Explanation / Answer

current approach

Automated approach

sales

2000000

2000000

variable cost

1500000

1000000

contribution margin

500000

1000000

fixed cost

380000

800000

EBIT

120000

200000

1-

contribution margin ratio = contribution/sales

500000/2000000

0.25

1000000/2000000

0.5

it is higher in case of automated approach

2-

break even point in dollars = fixed cost/contribution margin ratio

380000/.25

1520000

800000/.5

1600000

Higher level of sales would be needed to achieve the level of fixed cost

3-

Margin of safety = actual sales level-break even sales

2000000-1520000

480000

2000000-1600000

400000

it is higher in case of current approach

4-

operating leverage = contribution/ebit

500000/132000

3.7878788

1000000/200000

5

it is better for current approach as lower degree of operating leverage is generally preferred.

Decline in sales by 10% and its effect on ebit

degree of operating leverage*change in sales

-37.90%

5*-10%

-50.00%

new level of ebit

2000000*(1-.3790)

74520

200000*(1-.5)

100000

current approach

Automated approach

sales

2000000

2000000

variable cost

1500000

1000000

contribution margin

500000

1000000

fixed cost

380000

800000

EBIT

120000

200000

1-

contribution margin ratio = contribution/sales

500000/2000000

0.25

1000000/2000000

0.5

it is higher in case of automated approach

2-

break even point in dollars = fixed cost/contribution margin ratio

380000/.25

1520000

800000/.5

1600000

Higher level of sales would be needed to achieve the level of fixed cost

3-

Margin of safety = actual sales level-break even sales

2000000-1520000

480000

2000000-1600000

400000

it is higher in case of current approach

4-

operating leverage = contribution/ebit

500000/132000

3.7878788

1000000/200000

5

it is better for current approach as lower degree of operating leverage is generally preferred.

Decline in sales by 10% and its effect on ebit

degree of operating leverage*change in sales

-37.90%

5*-10%

-50.00%

new level of ebit

2000000*(1-.3790)

74520

200000*(1-.5)

100000

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