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# EAU Financial & Net Operating Income Analysis

Q1:

Al-Amal Company’s contribution format income statement for the most recent month on a sales volume of 20,000 units is given below (the relevant range of production is 10,000 units to 30,000 units):

(Answer each question independently and always refer to original data unless instructed otherwise)

1. Compute the break-even point in unit sales, and in sales revenue.
2. “The Sales manager was afraid that if sales drop to 10,000 units, the net operating income would decrease by 50%”, comment on the appropriateness of his thoughts? Explain in details showing calculations (hint: reproduce the contribution income

Net operating income
The company has a large amount of unused capacity and is studying ways of improving profit

statement to reflect the changes on the net operating income)

1. a. Compute the Degree of operating leverage.
b. Using the degree of operating leverage computed above, what is the estimated percent decrease in net operating income if sales drop by 50%? Show calculations to support your argument in (2) above.
2. New equipment has come on the market that would allow the company to automate a portion of its operations. Variable expenses would be reduced by AED 12 per unit. However, fixed expenses would increase to a total of AED 432,000 each month. Prepare a contribution format income statements to show how operations would appear if the new equipment is purchased.
3. Refer to the data in (4) above. As a manager, what is the risk associated in deciding whether to purchase the new equipment? Assume that ample funds are available to make the purchase, when would you recommend that the company automate its operations? Explain without calculations.

Question 2:

Max Company is a clothing manufacturer. One of its products is a plain T-shirts that normally sells for AED 20 per T-shirt. Max Company currently sells 4,000 T-shirts which is 80% of its overall capacity (5000 units). Following are the details of producing 4000 T-shirts:

refer to the second uploaded document Q2.Required:

1. Prepare a contribution format income statement (marginal costing)

Read carefully the below case and answer the following special-order questions accordingly:

The Emirates Airlines is the official sponsor of the tennis tournament and wanted to distribute a T-shirt holding its logo in special promotion throughout the tournament. Therefore, the Emirates Airlines approached Max Company to buy 1,000 T-shirts and offered a special price of AED 16 per T-shirt.

Max Company will have to incur an additional printing material cost of AED 2 per T- shirt to add the Emirates Airline logo, and would also require acquisition of a special tool costing AED 1,500 that would be used for this order only, there is no assurance that Emirates Airline will purchase additional units in the future. However, Max Company will get a quantity discount from its cloth (material) supplier of AED 1.5 per T-shirt for the additional T-shirts order.

There would be no sales commissions on this order which constitute one-third of the current variable selling expenses. However, a special packing is required that will increase the selling cost (variable) by AED 1.75 per T-shirt.
The manager of Max Company turned down the offer, saying, “If we sell at AED 16, and our cost is AED 19, we lose money on every T-shirt we sell”.

2. Compute the amount by which the operating income of Max Company will change (increase or decrease) if the Emirates Airlines offer is accepted. Do you agree with the manager in rejecting the offer?

1. In addition to considering the quantitative impact computed in requirement 2 above; list some qualitative considerations that would influence your decision.
2. If Emirates Airlines requested 2000 units instead of 1000 units, how this would affect your answer, explain briefly, no calculation is required.

Question 3:

Kamel Company has \$600,000 to invest and wishes to evaluate the following three projects.

1. which project(s) would you recommend using:

1. Payback Period (PP)
2. Net Present Value (NPV)
3. Profitability Index (PI)
4. The Internal Rate of Return (IRR) (hint: use 20% as cost of capital

[Notes: Present value of 1 = 1 / (1+ r)n , where: r = the discount rate, n = the number of years]
2. What are the advantages and disadvantages of the Payback Period Method?