Changes in Cost Structure; Break$-$Even Analysis; Operating Leverage; Margin of Safety $(45$ marks$)$

Frieden Company's contribution format income statement for last month is shown below:

Sales $(40,000$ units$)$ $ $800,000$

Variable expenses $560,000$

Contribution margin $240,000$

Fixed expenses $192,000$

Operating income $ $48,000$

$\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_$

Competition is intense, and Frieden Company$$s profits vary considerably from one year to the next. Management is exploring opportunities to increase profitability.

Required:

$1.$ Frieden$$s management is considering a major upgrade to the manufacturing equipment, which would result in fixed expenses increasing by $$240,000$ per month. However, variable expenses would decrease by $$6$ per unit. Selling price would not change. Prepare two contribution format income statements, one showing current operations and one showing how operations would appear if the upgrade is completed. Show an Amount column, a Per Unit column, and a Percentage column on each statement.

$2.$ Refer to the income statements in requirement $1$ above. For both current operations and the proposed new operations, compute $($a$)$ the degree of operating leverage, $($b$)$ the break$-$even point in dollars, and $($c$)$ the margin of safety in both dollar and percentage terms.

$3-$a$.$ Calculate the unit sales per month at which Frieden management will be indifferent between doing the major upgrade to the manufacturing equipment and not doing the upgrade.

$3-$b$.$ Based on the above analysis, should Frieden proceed with the major upgrade?

Yes

No

$3-$c$.$ Why or why not?

$4-$a$.$ Refer to the original data. Instead of doing the major upgrade to the equipment, management is considering introducing a new advertising campaign that will increase fixed expenses by $$20,000$ per month. Management believes the new advertisements will increase monthly unit sales by $10\%.$ In this case what would be imapact on operating income.

$4-$b$.$ Should Frieden proceed with the new advertising campaign?

Yes

No