The McPherson Company is facing a $6 increase in the variable cost of producing one of its products for the upcoming year. Because of this situation, the sales manager has made a proposal to increase the selling price of the product while increasing the advertising budget at the same time. The price increase will lower sales volume, but the other changes may help the company maintain its profit margins. McPherson has provided the following information regarding the current year results and the proposal made by the sales manager: Relative to the current year, the sales manager's proposal will:

Question

The McPherson Company is facing a $6 increase in the variable cost of producing one of its products for the upcoming year. Because of this situation, the sales manager has made a proposal to increase the selling price of the product while increasing the advertising budget at the same time. The price increase will lower sales volume, but the other changes may help the company maintain its profit margins. McPherson has provided the following information regarding the current year results and the proposal made by the sales manager:  Relative to the current year, the sales manager's proposal will:

Quizplus · Accepted Answer

The proposal of increasing the selling price of the product will decrease sales volume, which means a decrease in contribution margin. However, the proposed increase in advertising budget may help to increase sales volume.

To determine the effect of the proposal on operating income, we need to calculate the current year's operating income first.

Current year's operating income = (Sales - Variable Costs) - Fixed Costs
= (24,000 units x $60 selling price) - (24,000 units x $36 variable cost) - $600,000 fixed costs
= $840,000 - $864,000 - $600,000
= -$624,000 (a loss)

Now, let's calculate the effect of the proposal on operating income.

Proposal:
- Increase in variable cost per unit = $6
- Increase in selling price per unit = $8
- Decrease in sales volume = 20%

New contribution margin per unit = $32 ($8 increase in selling price - $6 increase in variable cost)
New sales volume = 19,200 units (20% decrease from 24,000 units)
New total contribution margin = $614,400 (19,200 units x $32)
New operating income = (New total contribution margin - Fixed Costs)
= ($614,400 - $600,000)
= $14,400

Therefore, the sales manager's proposal will decrease operating income by $624,000 - $14,400 = $609,600 or in other words, $610,000.

Hence, the correct answer is D, decrease operating income by $110,000 (not $90,000).

The McPherson Company Is Facing a $6 Increase in the Variable