The Butterfly Earthmover Company has experienced an increase in sales of about 35% during the past year relative to last year. While this is good news, the company has NOT been able to increase its production capacity fast enough. Management does not want to continue to turn away projects because it cannot keep up with the increased demand.
A consultant was hired to study the situation and has recommended that consideration be given to the purchase of automated painting stations. These stations would, according to the consultants, be a significant move in the right direction. This direction is away from manual and toward automation. Unfortunately, about 18% of the company's workforce would have to be layed off.
Butterfly's financial management compiled financial information and put together a comparison of manual versus automation. Note below that the automation appears more profitable.
Manual Automation
Sales $ 5,000,000 $ 5,000,000
Variable Costs 3,750,000 2,500,000
Contribution Margin 1,250,000 2,500,000
Fixed Cost 921,500 1,940,000
Net Income $ 328,500 $ 560,000
INSTRUCTIONS:
1. Compute the contribution margin ratio for each approach. Interpret the contribution margins. Be specific.
2. What is the beak-even point in sales for each approach? What are the implications of your findings? Be specific.
3. Determine the degree of operating leverage for each approach? What would happen to the company's net income for each approach if sales declined 10%? Discuss clearly.
4. At what sales level would the company's net income be the same for either approach?
5. What would you recommend based on the information provided? What additional information would you like to have? Be Specific.