Electro Systems manufactures relays and currently sells 200,000 units annually to producers of electronic equipment. Mac Scott, president of the company, anticipates a 20 percent increase in the cost per unit of direct labor on January 1 of next year. He expects all other costs and expenses to remain unchanged. Scott has asked you to assist him in developing the information he needs to formulate a reasonable product strategy for next year.

You are satisfied that volume is the primary factor affecting costs and expenses and have separated the semivariable costs into their fixed and variable segments. Beginning and ending inventories remain at a level of 3,000 units. Current plant capacity is 210,000 units.

Below are the current-year data assembled for your analysis:

Instructions
a. What increase in the selling price is necessary to cover the 20 percent increase in direct labor cost and still maintain the current contribution margin ratio of 60 percent?
b. Approximately how many units must be sold to maintain the current operating income of $800,000 if the sales price remains at $15 and the 20 percent wage increase goes into effect?
c. Scott believes that an additional $500,000 of machinery (to be depreciated at 20 percent annually) will increase present capacity (210,000 units) by 5 percent. If all units produced can be sold at the present price of $15 per unit and the wage increase goes into effect, how would the estimated operating income before capacity is increased compare with the estimated operating income after capacity is increased? Prepare schedules of estimated operating income at full capacity before and after the expansion.

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$15 Sales price per unit. . . Variable costs per unit: . Direct materials Direct labor . .. Manufacturing overhead and selling and administrative $3 2 6 $ 9 expenses Contribution margin per unit (60%). Fixed costs $1,000,000