Scenario

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Part 3

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Part 3

Elke correctly documents the expected cost of goods sold in her budget. By subtracting the cost of goods sold and non-production costs from revenues, she arrives at a projected operating income of about $300,000 for her division—only a 5% increase over last year's operating income of $285,500.

Ahmed encourages her to find a way to boost operating income further. "Try some 'what-if' scenarios in your budget," he suggests."Figure out what the operating income would be if you reexamined some of your assumptions about revenues and costs."

Elke comes up with several "what-if" scenarios.She studies the relevant data to determine which scenario would yield the best results.

What-If Scenario

Units Sold

Direct Materials Cost

Operating Income

Current projected budget

21,400

214,000

300,000

Increase unit sales 10%

23,540

235,400

330,000

Increase unit sales 5%

22,470

224,700

315,000

Decrease materials cost 5%

21,400

203,300

312,000

 Which "what-if" scenario should Elke select?

Explore all the choices.

  • Increase unit sales by 10% to assure a dramatic increase in operating income

  • Not the best choice. It may be tempting to adopt this strategy because it assures a dramatic increase in operating income. But boosting unit sales 10% would likely require additional salespeople and would also dramatically raise direct materials costs. Ahmed has explained that the company does not want to see costs increase, so Elke should consider other options instead.

  • Increase unit sales 5% to nudge operating income higher without raising cost of goods sold too radically

  • Not the best choice. This scenario would boost operating income to $315,000 (roughly 10% over last year's figure of $285,500). But it would also increase direct materials costs 5% (from $214,000 to $224,700). Ahmed has stressed the importance of controlling costs, so Elke should explore other possible scenarios that might meet both of the goals he specified.

  • Decrease materials cost 5% to achieve a good result while still taking into account the company's strategic goals

  • The best choice

    Correct choice. This option meets both of the goals Ahmed specified: raising operating income by close to 10%, while controlling costs as much as possible. This scenario actually decreases materials costs. At the same time, it yields an operating income of $312,000, which is roughly a 9.5% increase over last year's $285,500 figure. Ahmed would likely find this scenario most appealing.

    When evaluating "what-if" scenarios, weigh all the factors involved to identify the best possible scenario. Don't select one scenario just because it yields the highest possible number you're interested in. Implementing that scenario may entail a trade-off that could conflict with your company's larger strategic goals.

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