126) What are the advantages and the disadvantages of using break-even analysis?
Mini-Case 11-1: Bowden Brake Service (Part A)
Jim Bowden, owner of Bowden Brake Service, is planning to expand his six-year-old brake
service to include tune-ups and tire services. Based on budget estimates for the upcoming year,
Jim expects net sales to be $825,000 with a cost of goods sold of $530,000 and total operating
expenses of $210,000. From the budget he created, Jim computes fixed expenses to be $168,000,
while variable expenses (including cost of goods sold) are $572,000. Jim is concerned that the
new cost structure may damage his ability to produce a profit and he wants to perform a break-
even analysis for the upcoming year to gain insight.
127) If Jim were to reduce his fixed costs by 10 percent by reducing a middle management
position, what benefit would that be to him and the company? What would his new contribution
margin be?
128) Help Jim compute the break-even point for his brake service.
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Mini-Case 11-2: Bowden Brake Service (Part B)
One day while you are in Bowden Brake Service getting your brakes repaired, Jim storms into
his office, slamming doors and shouting about the local financial institutions. After a few
minutes of building your courage, you approach Jim and ask him what the problem is. He shouts,
“It’s the financial institutions in this town! Not one of them will lend me the money I need to
expand my business. They all said I needed to take a closer look at my financial position before I
consider expanding. One of them said something about ratio analysis. I know a lot about cars and
brakes, but what is ratio analysis?”
You tell Jim you will perform a ratio analysis for the business if he gives you a free brake job.
Jim provides you with the following financial statements.
Bowden Brake Service
Income Statement
Year Ending December 31, 2007
Net Sales $780,000
Costs of Goods Sold:
Beginning Inventory $104,000
Purchases 526,480
Goods Available for Sale $630,480
Ending Inventory 134,400
Costs of Goods Sold 496,080
Gross Margin $283,920
Operating Expenses:
Rent 24,000
Insurance 5,250
Advertising 6,000
Travel 2,500
Interest 72,750
Taxes (property, etc.) 2,500
Salaries & Admin. Expenses 97,000
Utilities 12,500
Supplies 1,360
Total Operating Expenses $223,860
Net Profit $60,060
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Bowden Brake Service
Balance Sheet
December 31, 2007
Assets
Current Assets:
Cash $20,000
Accounts Receivable 10,000
Notes Receivable 5,000
Inventory 134,400
Total Current Assets $169,400
Fixed Assets:
Land 147,000
Machinery 73,000
Equipment 160,800
Less Accumulated Depreciation (30,200) 203,600
Total Fixed Assets 350,600
Total Assets $520,000
Liabilities & Owner’s Equity
Current Liabilities:
Accounts Payable 40,500
Notes Payable 20,200
Accrued Salaries Payable 4,300
Total Current Liabilities: 65,000
Long-term Liabilities: Long-term Loan 325,000
Total Liabilities $390,000
Owner’s Equity, Jim Bowden $130,000
Total Liabilities and Net Worth $520,000
129) Refer to the income statement and balance sheet. Prepare a ratio analysis for Bowden Brake
Service. In addition, use the following industry statistics for firms like Jim’s to explain and
interpret what these ratios mean.
130) Were the bankers correct? Do you think Jim should expand the business?
Mini-Case 11-3: Birmingham’s Stereo Shop
Birmingham’s Stereo Shop expects net sales of $280,000 in the upcoming year, with a cost of
goods sold of $173,600 and total expenses of $76,200. Birmingham expects variable expenses
(including cost of goods sold) to be $195,700 and fixed expenses to be $54,100.
131) What level of sales would Birmingham’s have to achieve if it wanted to make a $25,000
profit?
132) Construct a break-even chart for Birmingham’s.
133) Compute a break-even point in dollars.
Mini-Case 11-4: Calculating the Break-even Point
A small manufacturer plans to sell tents for $120 each. The variable cost for each tent is $90.
Fixed costs for the process are estimated to be $36,000. How many tents must the company sell
to break-even?
134) Suppose that the manufacturer desires a profit of $9,000 on this product. How many units
must be sold?
Mini-Case 11-5: A Projected Income Statement
You want to start your own retail furniture store, and you have already gathered a great deal of
information on location, layout, form of ownership, business failure rates, etc. In applying for a
loan, you notice that a projected income statement is required. Your problem is to complete this
projected “P&L,” given a desired income of $23,000 and the following published statistics. Show
and clearly label all of your work!
Cost of Goods Sold 60.3 percent of net sales
Operating Expenses 36.4 percent of net sales
Gross Profit Margin 39.7 percent of net sales
135) If a market survey indicates that your firm’s sales would be $620,000, what net profit would
you expect to earn?
Mini-Case 11-6: Crazy Harry’s
The following is a pro forma income statement for Crazy Harry’s.
Crazy Harry’s
Pro Forma Income Statement
Sales $96,000
Cost of Goods Sold 46,240
Gross Profit $49,760
Fixed Expenses
Rent $2,400
Insurance 3,000
Salaries 16,500
Taxes 1,100
Miscellaneous Fixed Expenses 900
Total Fixed Expenses $23,900
Variable expenses
Wages $11,200
Advertising 5,700
Benefits 2,800
Other Variable Expenses 1,120
Total Variable Expenses $20,080
Net Profit $5,040
136) Calculate Harry’s break-even point.
137) Create a break-even chart for Harry.
138) If Harry’s profit target is $15,000, what level of sales must be achieved?
Mini-Case 11-7: Sharps and Flats
Anthony Gray has been interested in music since he was old enough to sit at the piano. He
literally grew up with music, and he used his talent to earn his way through college. Anthony has
grown tired of his job at a large music house in Houston and is seriously considering moving
back to his hometown in Massachusetts to open his own small music shop. In researching this
venture, Anthony notices that he must include a projected income statement in his loan
application. Use the following statistics from Robert Morris Associates’ Annual Statement
Studies to answer the following question(s).
Net sales 100.0 percent
Cost of sales 59.9 percent
Gross profit 40.1 percent
Operating expenses 31.2 percent
Net profit (before taxes) 8.9 percent
139) Suppose that a market survey indicates that Anthony’s proposed business is likely to
generate only $190,000 in sales. What net profit should Anthony expect to earn?
140) Using Anthony’s target income of $23,000, construct a pro forma income statement for
Anthony’s proposed music shop.
Net sales $258,427
Cost of goods sold 254,798
Gross profit 103,629
Operating expenses 80,629
Net profit (before taxes) $23,000