Data for Hermann Corporation are shown below:

Per unit Percent

of Sales

Selling price $90 100%

Variable expenses

63

70%

Contribution margin

$27

30%

Fixed expenses are $30,000 per month and the company is selling 2,000 units per month.

Requirement 1:

(a)

Calculate the increase or decrease in net operating income if a $5,000 increase in the monthly advertising budget would increase monthly sales by $9,000.

net operating income:?

(b) Should the advertising budget be increased as suggested in requirement 1 (a) above?

Requirement 2:

Refer to the original data. Management is considering using higher-quality components that would increase the variable cost by $2 per unit. The marketing manager believes the higher-quality product would increase sales by 10% per month. Should the higher-quality components be used?

a) We get $28000 Net Profit if we use advertising expense of $ 5000

b) Yes the higher components should be used as they increase the net profit by $42000 - $24000 = $ 18000

Explanation:

a) The difference between the earlier and later net profit is of $ 4000.

We get $ 24000 Net Profit if we do not use advertising expense and $ 28000 if we use advertising expense of $ 5000

Hermann Corporation

Per unit Percent Total

Sales

Selling price $94.5 100% 189,000

Variable expenses 63 67% 126,000

Contribution margin $27 33% 63000

Fixed expenses $30,000

Advertising Expenses $ 5000

Net Profit $ 28000

Hermann Corporation

Per unit Percent Total

Sales

Selling price $90 100% 180,000

Variable expenses 63 70% 126,000

Contribution margin $27 30% 54000

Fixed expenses $30,000

Net Profit $ 24000

b) Yes the higher components should be used as they increase the net profit by $42000 - $24000 = $ 18000

Hermann Corporation

Per unit Percent Total

Sales

Selling price $99 100% 198,000

Variable expenses 65 66% 126,000

Contribution margin $27 44% 72000

Fixed expenses $30,000

Net Profit $ 42,000