EXERCISE 6-4 (20 MINUTES)

1. The following table shows the effect of the proposed change in monthly

advertising budget:

Sales With

Additional

Current Advertising

Sales Budget Difference

Sales... $180,000 $189,000 $ 9,000

Less variable expenses .... 126,000 132,300 6,300

Contribution margin ... 54,000 56,700 2,700

Less fixed expenses... 30,000 35,000 5,000

Net operating income ... $ 24,000 $ 21,700 $(2,300)

Assuming no other important factors need to be considered, the in-

crease in the advertising budget should not be approved since it would

lead to a decrease in net operating income of $2,300.

Alternative Solution 1

Expected total contribution margin:

$189,000 × 30% CM ratio... $56,700

Present total contribution margin:

$180,000 × 30% CM ratio... 54,000

Incremental contribution margin ... 2,700

Change in fixed expenses:

Less incremental advertising expense... 5,000

Change in net operating income ... $(2,300)

Alternative Solution 2

Incremental contribution margin:

$9,000 × 30% CM ratio ... $ 2,700

Less incremental advertising expense ... 5,000