Question

Pharoah Company reports the following operating results for the month of August: sales $360,000 (units 4,800), variable costs $245,000, and fixed costs $92,000. Management is considering the following independent courses of action to increase net income. 1. Increase selling price by 12% with no change in total variable costs or units sold. 2. Reduce variable costs to 61% of sales. Compute the net income to be earned under each alternative.

Answer 1

For Pharaoh Company, Alternative 1 results in a net income of $66,200 after increasing the selling price by 12%, whereas Alternative 2 leads to a net income of $48,400 by reducing variable costs to 61% of sales. Alternative 1 yields a higher increase in net income.

Step-by-step explanation:

To calculate the net income under the two different alternatives provided by Pharaoh Company, we must apply basic accounting and managerial principles. We begin with the current operating results: sales of $360,000, variable costs of $245,000, and fixed costs of $92,000. From this, we can calculate the current net income before considering the alternatives.

Current Net Income = Sales - Variable Costs - Fixed Costs
= $360,000 - $245,000 - $92,000
= $23,000

Alternative 1: Increase selling price by 12%.

New Sales = Sales + (Sales * 12%)
= $360,000 + ($360,000 * 0.12)
= $360,000 + $43,200
= $403,200

Net Income under Alternative 1 = New Sales - Variable Costs - Fixed Costs
= $403,200 - $245,000 - $92,000
= $66,200

Alternative 2: Reduce variable costs to 61% of sales.

New Variable Costs = Sales * 61%
= $360,000 * 0.61
= $219,600

Net Income under Alternative 2 = Sales - New Variable Costs - Fixed Costs
= $360,000 - $219,600 - $92,000
= $48,400

Comparing the two alternatives, Pharaoh Company would have higher net income by choosing Alternative 1.

Answer 2

1. Net Income = $66,200

2. Net Income = $91,600

Step-by-step explanation:

Requirement 1

Original sales = $360,000

If we increase the sales by 12%,

The new sales = $360,000 + ($360,000 × 12%) = $403,200

Pharoah Company

Income statement

Sales revenue = $403,200

Less: Variable cost = ($245,000)

Contribution margin = $158,200

Less: fixed costs = ($92,000)

Net income = $66,200

Note: The company increases the sales but does not change the costs.

Requirement 2

Original sales = $360,000

If we decrease the variable expense to 61% of sales,

The new variable expense = $360,000 × 61% = $219,600

Pharoah Company

Income statement

Sales revenue = $403,200

Less: Variable cost = ($219,600)

Contribution margin = $183,600

Less: fixed costs = ($92,000)

Net income = $91,600

Note: The company reduces the variable costs but not changes sales or fixed costs.