Data for Hermann Corporation are shown below:

Per unit Percentage of sale

Selling price $75 100%

expenses 51 68

contribution margin 24% 32%

Fixed expenses are $75,000 per month and the company is selling 4,000 units per month.

Required:

a. How much will net operating income increase (decrease) per month if the company uses higher-quality components that increase the variable expense by $4 per unit and increase unit sales by 25%.

b. Should the higher-quality components be used?

Instructions are below.

Explanation:

Giving the following information:

Selling price = $75

expenses = $51

contribution margin = $24

Fixed expenses are $75,000 per month and the company is selling 4,000 units per month.

Higher quality:

Variable cost = $55

Increase in sales = 4,000*1.25 = 5,000

First, we need to determine the effect on the income:

Effect on income = 1,000 * (75 - 55) - 4,000*4

Effect on income = $4,000 increase

The higher quality component should be used because of income increase.