[The following information applies to the questions displayed below.]

Data for Hermann Corporation are shown below:

Per Unit Percent
of Sales
Selling price $ 80 100%
Variable expenses 52 65%
Contribution margin $ 28 35%

Fixed expenses are $76,000 per month and the company is selling 4,600 units per month.

Required:
1-a.
The marketing manager argues that a $10,000 increase in the monthly advertising budget would increase monthly sales by $25,000. Calculate the increase or decrease in net operating income.

1-b. Should the advertising budget be increased?
Yes
No
2-a.

Refer to the original data. Management is considering using higher-quality components that would increase the variable expense by $5 per unit. The marketing manager believes that the higher-quality product would increase sales by 25% per month. Calculate the change in total contribution margin.

2-b. Should the higher-quality components be used?
Yes
No

Instructions are listed below.

Explanation:

Giving the following information:

Selling price $ 80

Variable expenses (52)

Contribution margin $ 28

Fixed expenses are $76,000 per month and the company is selling 4,600 units per month.

1) Increase in marketing= 10,000

Increase in sales= 25,000

We need to calculate the effect on income:

Effect on income= increase in contribution margin - increase in fixed costs

Effect on income= 25,000*0.35 - 10,000= -$1,250

The increase in marketing wouldn't increase income. It has a negative effect.

2) Increase in variable cost= $5

Increase in sales= 25%= 4,600*1.25= 5,750

New unitary contribution margin:

unitary contribution margin= 80 - 57= $23

Total contriburion margin= 5,750*23= $132,250

To determine whether it is convenient or not, we need to calculate the previous total contribution margin:

Total contribution margin= 28*4,600= $128,800

It is more profitable to incorporate a higher quality component.

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