Q46PGB - Horngren'S Financial And Managerial Accounting

Question

Using sensitivity analysis Caputo Company prepared the following budgeted income statement for the first quarter of 2018:

 

Caputo Company is considering two options. Option 1 is to increase advertising by \(1,100 per month. Option 2 is to use better-quality materials in the manufacturing process. The better materials will increase the cost of goods sold to 55% but will provide a better product at the same sales price. The marketing manager projects either option will result in sales increases of 25% per month rather than 20%. 

Requirements 

1. Prepare budgeted income statements for both options, assuming both options begin in January and January sales remain \)10,000. Round all calculations to the nearest dollar. 

2. Which option should Caputo choose? Explain your reasoning.

 

Step-by-Step Solution

Answer

1. Budget, option 1 - $4,239 and option 2 - $4,375
2. Holly should choose option 2.

Step 1: Preparation of budget under both options

 

Option 1:

CAPUTO COMPANY Budgeted Income Statement For the quarter ended March 31, 2018
	January	February	March	Total
Net sales revenue (25% increase per month)	$10,000	$12,500	$15,625	$38,125
Cost of Goods Sold (50% of sales)	5,000	6,250	7,813	19,063
Gross profit	5,000	6,250	7,812	19,062
S&A Expenses ($4,100 + 5% of sales)	4,600	4,725	4,881	14,206
Operating income	1,600	1,525	2,931	6,056
Income Tax Expense (30% of operating income)	480	458	879	1,817
Net Income	$1,120	$1,067	$2,052	$4,239

 

Option 2:

CAPUTO COMPANY Budgeted Income Statement For the quarter ended March 31, 2018
	January	February	March	Total
Net sales revenue (25% increase per month)	$10,000	$12,500	$15,625	$38,125
Cost of Goods Sold (55% of sales)	5,500	6,875	8,594	20,969
Gross profit	4,500	5,625	7,031	17,156
S&A Expenses ($3,000 + 5% of sales)	3,500	3,625	3,781	10,906
Operating income	1,000	2,000	3,250	6,250
Income Tax Expense (30% of operating income)	300	600	975	1,875
Net Income	$700	$1,400	$2,275	$4,375

 

Step 2: Sensitivity Analysis

Holly should choose option 2 because under option 1 the company will earn $4,375.