Reference no: EM132946681
Question - Mr. Hugh and Mr. Lowe are the presidents of their respective companies. The two firms manufacture and sell the same product, and due to the competitive nature of the market, they charge the same selling price.
High and Lowe differ regarding their production and management philosophies. The High Company is almost completely automated, and the labour force is paid on a fixed salary basis. The Lowe Company uses a high degree of manual labour paid on an hourly basis. The sales force at the High Company is paid fixed annual salaries with very small commissions whereas the sales force at Lowe Company is paid strictly on commission basis. Mr. Lowe constantly makes fun of Mr. High's operations, saying the High Company is inflexible and unable to adjust costs as sales volume fluctuates.
During 2007, both the firms reported net income of $ 12,000 on sales of $ 120,000. However, Mr. Lowe was shocked when examining the results for 2008, which showed that the High Company's profits were far ahead of Lowe Company's, even though Lowe Company had higher sales. The results for the two years are as follows:
|
|
High Company
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Lowe Company
|
|
2007
|
2008
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2007
|
2008
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|
Sales Revenue
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$120,000
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$150,000
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$120,000
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$80,000
|
|
Total costs
|
108,000
|
114,000
|
108,000
|
156,000
|
|
Net income
|
12,000
|
36000
|
12000
|
24000
|
|
Net income as a percentage of Sales
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10%
|
24%
|
10%
|
13%
|
|
Fixed expenses for each year
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$84000
|
12,000
|
Mr. Lowe is trying to figure out why the profits increase of his company was less than that of High Company. His company's accountant's carefully examined the costs for each year and found no operating inefficiencies or costs that were out of line. He has hired you as a consultant.
Required -
A. Present the income statements for 2007 and 2008 for both companies in contribution margin format.
B. Compute the break-even point in dollar sales and the margin of safety for each company.
C. Prepare explanation for Mr. Lowe showing why Lowe Company's profits for 2008 were lower than those reported by High Company despite the fact that Lowe Company's sales were higher.
D. What volume of sales would Lowe Company have to achieve to make the same profit as High Company in 2008?
E. Comment on the relative position of the two companies if sales in the future begin to decline.