Reference no: EM132577277
Ivan Co. (Ivan) currently produces a single product, OP. Budgeted operating information for expected sales of 40,000 units is as follows:
Sales $2,000,000
Cost of goods sold $ 300,000
Variable manufacturing costs 600,000
Fixed manufacturing costs $ 900,000
Gross profits $1,100,000
Selling and administrative expenses $ 180,000
Sales commission (9% of selling price) 266,000
Fixed advertising expenses 350,000
Fixed administrative expenses $ 796,000
Operating income before taxes $ 304,000
Income tax (40%) 121,600
Net income $ 182,400
Fixed manufacturing costs are allocated at a rate of $2.50 per machine hour. Ivan's management is considering the introduction of a new product, NZ, to diversify its product lines and use up all available machine hour capacity. Ivan estimates the following sales and costs related to NZ:
Expected sales 10,000 units
Selling price per unit $20
Variable manufacturing cost per unit $9
Fixed manufacturing cost (allocated) per unit $5
Sales commission per unit (15% of selling price) $3
Incremental fixed advertising expenses $32,000
Incremental fixed administrative expenses $16,000
Required:
Question a) Assume that Ivan produces OP only. Calculate Ivan's margin of safety.
Question b) Assume that Ivan starts producing NZ, and that the estimates above occur as expected. Calculate Ivan's new margin of safety.
Question c) Calculate the impact to Ivan's operating income before taxes if both OP and NZ are produced, and discuss whether Ivan should diversify its product line.