Incremental Application Solution - ABC Company Currently Sel

Incremental Application Solutionabc Company Currently Sells 400 Units

ABC Company currently sells 400 units of a product at a price of $250 per unit, with variable costs of $150 per unit. This gives us a contribution margin per unit of $100 ($250 - $150). The total contribution margin is calculated as $40,000 ($100 x 400 units). The contribution rate, which is the contribution margin divided by sales price, is 40% ($100 / $250). These figures establish the baseline financial metrics necessary for analyzing various incremental decisions that ABC Company may face.

Paper For Above instruction

Analyzing incremental decisions is crucial for companies like ABC to optimize profitability and strategic positioning. Each scenario involves assessing additional revenues, costs, and potential changes in sales volume to determine whether specific actions will enhance overall financial performance. This paper examines seven key incremental applications, providing a comprehensive evaluation of their potential impacts on ABC Company’s profitability.

Scenario 1: Increasing Advertising Spending

Increasing advertising expenditure by $10,000, which is projected to generate an additional $30,000 in sales revenue, requires analyzing whether this investment is justified based on the contribution margin rate. Given the contribution rate of 40%, the additional contribution attributable to sales increase would be 40% of $30,000, equaling $12,000. Since the advertising expense of $10,000 costs less than the additional contribution ($12,000), the company would see a net benefit. Precisely, the net increase in contribution margin would be $2,000 ($12,000 - $10,000). Therefore, from a purely incremental contribution perspective, the company should proceed with increasing advertising because it enhances profitability.

Scenario 2: Decreasing Variable Costs and Sales Decline

Next, consider reducing variable costs per unit by $25, which would decrease variable costs from $150 to $125 per unit. However, this change would result in a drop in sales volume from 400 units to 350 units. Calculating the new total contribution involves assessing the contribution per unit now at $125 (since sales price remains at $250). The new total contribution would be $125 x 350 units = $43,750. Previously, total contribution was $40,000, so despite lower sales volume, the total contribution increases by $3,750, making this a favorable decision from a contribution perspective.

Scenario 3: Reducing Price and Increasing Advertising

In this scenario, dropping the unit price by $20 (to $230) and investing $15,000 in advertising aims to increase sales volume by 50%. The new price per unit would be $230. The new sales volume would be 600 units (400 + 50%), generating revenue of $138,000. The increased advertising expense of $15,000 reduces from the additional revenue a net benefit analysis. The contribution margin per unit now becomes $80 ($230 - $150). Total contribution would be $80 x 600 = $48,000. Deducting the advertising cost, the net contribution is $33,000, which exceeds the original contribution of $40,000, indicating that unless the increase in sales volume and consequent contribution margin boosts outweigh the advertising cost, this action's benefit is marginal and should be carefully evaluated. Since the total contribution after changes ($48,000) exceeds the original ($40,000), this scenario appears advantageous.

Scenario 4: Changing Sales Compensation and Salaries

Implementing a commission of $15 per unit sold, expecting a 15% increase in sales volume, while reducing salaries by $6,000, involves evaluating both the additional contribution and cost savings. The previous volume is 400 units; a 15% increase results in 460 units. The total variable cost per unit remains at $150, so contribution per unit remains at $100. The total contribution with increased sales would be $100 x 460 = $46,000. The commission expense would be $15 x 460 units = $6,900. Accounting for the salary reduction of $6,000, the net variable costs increase by only $900 in commissions. Considering fixed costs are unchanged, the net contribution increases, indicating the company should pursue this plan as it enhances profitability.

Scenario 5: Bulk Sale Pricing for a 150-Unit Order

Suppose ABC has the opportunity to sell 150 units at a bulk price aiming for a $3,000 profit. To determine the appropriate price, we need to establish the break-even price per unit that covers variable costs and contributes toward the desired profit. The total variable cost for 150 units at $150 per unit is $22,500. Adding the $3,000 profit target, the total revenue must be at least $25,500. Dividing this by 150 units yields a minimum price of $170 per unit. Therefore, to earn a $3,000 profit on a 150-unit bulk sale, ABC should price the units at $170 or higher, considering any additional costs or discounts that may apply.

Scenario 6: Additional Orders During a Slump

During a sales slump with only 200 units sold at $250 each, a potential order for 50 units involving an additional variable cost of $50 per unit warrants careful consideration. The total variable cost for the 50 units would be $2,500 ($50 x 50 units). Including this order increases total variable costs and sales revenue by $12,500 (50 units x $250). The contribution margin per standard unit is $100; for these additional units, the contribution margin per unit drops to $100 - $50 = $50. The net contribution from these additional units would be $50 x 50 = $2,500, which covers the additional variable costs. However, fixed costs remain unchanged at $30,000. Since the incremental contribution is positive, accepting the order is profitable, provided it does not cannibalize existing sales or lead to price reductions in general sales. The decision favors acceptance due to positive incremental contribution, despite the lower contribution margin on the additional units.

Conclusion

Overall, analyzing incremental decisions involves assessing the marginal impact on contribution margin, fixed costs, and overall profitability. For ABC Company, scenarios such as increased advertising that generates higher sales, strategic cost reductions, and selectively accepting bulk or special orders can be beneficial if their incremental contribution outweighs associated costs. Conversely, price cuts or reductions in variable costs must be carefully evaluated to ensure they result in a net positive impact. Proper application of contribution margin analysis supports strategic decision-making, allowing ABC to optimize its profitability in varying market conditions.

References

• Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2020). Managerial Accounting (8th ed.). McGraw-Hill Education.