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# Contribution Margin

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2. Larimer Industries is a division of Widgetco, a diversified manufacturer whose divisions are profit centers. Larimer makes a single product, X47, in its plant, which has a capacity of 18,000 units/month. At the normal volume of 10,000 units/month, X47 has a unit cost of \$750, consisting of: direct materials, \$260; direct labor, \$180; overhead, \$310. Manufacturing overhead has both fixed and variable components. Fixed overhead is applied at a rate of 150% of direct labor cost. Fixed selling and administrative costs are \$620,000/month. Several other companies also make an equivalent product. The market price is normally \$900/unit.
a. Prepare a monthly income statement for Larimer Industries at a sales volume of 10,000 units, using the contribution format. Note that there is no interest or income tax expense, because Larimer is simply a division of the corporation.
b. What is the breakeven level of sales in units per month (round to the nearest whole unit)?
c. The marketing department has proposed an ad campaign for next year that will cost \$400,000. How many additional units must be sold at the regular price in order for this campaign to yield an incremental profit of \$150,000 (round to the nearest whole unit)?
d. Windsor Division of Widgetco is developing a new product for which X47 would be an input. What factors would influence the managers of Larimer and Windsor as they negotiate a transfer price?

## SOLUTION This solution is FREE courtesy of BrainMass!

Calculating the unit variable costs:
The overhead consists of fixed and variable overhead. The fixed overhead is 150% of direct labor cost or 150% of \$180 = \$270. The variable overhead is \$310 - \$270 = \$40.
Therefore the unit variable cost is \$260 + \$180 + \$40 = \$480

Total fixed costs consist of:
Fixed overhead cost = 10,000 * \$270 = \$2,700,000 per month
Fixed selling and administrative costs = \$620,000 per month

Monthly income statement in contribution format
Sales = 10,000 * \$900 = \$9,000,000
Variable costs = 10,000 * \$480 4,800,000
Contribution margin (sales - variable costs) 4,200,000
Fixed selling and administrative costs 620,000
Net income (contribution margin - fixed costs) \$ 880,000

Variable contribution margin per unit = \$900 - \$480 = \$420
Break-even = (\$2,700,000 + \$620,000)/\$420 = 7,905 units

Additional units = (\$400,000 + \$150,000)/\$420 = 1,310 units

Since each division is a profit center the managers of Larimer and Windsor are going to try to maximize their profit.
The minimum price charged by managers of Larimer will be the variable costs: \$420
The maximum price paid by managers of Windsor will be the market price (price charged for similar product by other manufacturers): \$900
The negotiated price will be between the variable costs and the market price: \$420 - \$900.
The maximum number of units produced per month will be the excess capacity or 18,000 - 10,000 = 8,000

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