Upload: Contribution Margin Ratio Essay

Week 4 Case Study Learning Team A
“Managerial Analysis

BYP6-2

For nearly 20 years Custom 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 Custom 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 Custom Coatings has had to turn work away because it cannot keep up with customer requests.

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 Custom 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 approach (WileyPLUS, 2015.)”

Current Approach
Automated Approach
Sales
$2,000,000
$2,000,000
Variable costs 1,200,000 400,000
Contribution margin 800,000 1,600,000
Fixed costs 200,000 600,000
Net income
$ 600,000
$1,000,000

Instructions

(a)
Compute and interpret the contribution margin ratio under each approach.

The formula for calculating the contribution margin ratio is: Sales – Variable Costs ------------------------------------ Sales Current Automated Current Automated
2,000,000 – 1,200,000 2,000,000 – 400,000 800,000 1,600,000
--------------------------- --------------------------- ------------- ------------- 2,000,000 2,000,000 2,000,000 2,000,000

Current Automated 40% 80%

(b)
Compute the break-even point in sales dollars under each approach. Discuss the implications of your findings. The break-even point in sales dollars calculates by dividing a company's fixed expenses by the company's contribution margin ratio.
So we need to find out the contribution margin ratio:
Contribution margin ratio: contribution margin/sales
Therefore:
Current Approach:
Sales dollars: $ 2,000,000
Contribution margin ratio: $ 800,000/$ 2,000,000 = 40%
Break-even point in Sales = Fixed Costs/Contribution Margin Ratio
200,000/40% = $ 500,000
Automated Approach:
Sales Dollars $ 2,000,000
Contribution margin ratio: $ 1,600,000/ $2,000,000 = 80%
Break-even point in Sales = Fixed Costs/Contribution Margin Ratio 600,000/80% = $ 750,000

It looks like when in the automated approach, the company would need to make $250,000 more in sales dollars to break even as compared to the current approach.
To calculate the breakeven point in sales dollars, you will need to divide fixed costs by the contribution margin ratio. The

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