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36
Mini-Case 12-2: 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
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
115) Were the bankers correct? Do you think Jim should expand the business?
116) The break-even point ________.
A) occurs where a company's total revenue equals its total expenses
B) is the point at which a company neither earns a profit nor incurs a loss
C) tells a business owner the minimum level of activity needed to keep her company in operation
D) All of the above
117) Which of the following is an assumption of break-even analysis?
A) Fixed expenses remain constant for all levels of sales volume.
B) Variable expenses change in direct proportion to changes in sales volume.
C) Changes in sales volume have no effect on unit sales price.
D) All of the above
118) Refer to the following information:
Smith Office Supply Industry Mean
Current Ratio 2.3 1.8
Quick Ratio .4 .8
Average Inventory Turnover 2.0 3.9
Net Sales-to-Working Capital 4.0 7.8
Debt-to-Net Worth Ratio 3.0 1.7
Net Profit to Equity Ratio 40.1 percent 22.2 percent
Which of the following statements is most likely false?
A) Smith relies heavily on inventory to meet its debt obligations.
B) Smith is sufficiently capitalized.
C) Smith's sales are inadequate.
D) Smith's prices may be too high and/or the inventory too "stale."
Refer to the following Gunther's Emporium information to answer the question(s) below:
Gunther's Emporium expects net sales of $2,396,919 for the upcoming year, with variable
expenses totaling $1,813,443 and fixed expenses of $412,190.
119) Using break-even analysis, what is Gunther's contribution margin?
A) 4 percent
B) 32 percent
C) 24 percent
D) 12 percent
120) Gunther's Emporium expects net sales of $2,396,919 for the upcoming year, with variable
expenses totaling $1,813,443 and fixed expenses of $412,190. What is Gunther's break-even
point?
A) $1,876,324
B) $1,693,276
C) $5,667,009
D) Insufficient information given to determine.
121) If Gunther's net profit target for the year is $190,000, what sales level must he achieve?
A) $2,473,796
B) $1,876,324
C) $5,667,009
D) None of the above
Refer to the following break-even chart to answer the question(s) below:
122) Line T is the ________ line, while line S is the ________ line.
A) total revenue; total expense
B) total expense; total revenue
C) fixed cost; variable cost
D) variable cost; fixed cost
123) The area labeled ________ represents the firm's fixed expenses, while ________ represents
its variable expenses.
A) Z; W
B) X; Y
C) Y; X
D) W; Z
124) The area labeled ________ is the "profit area."
A) W
B) X
C) Y
D) Z
125) The area labeled ________ is the "loss area."
A) W
B) X
C) Y
D) Z
126) The break-even point is the level of operation at which a business neither earns a profit nor
incurs a loss, and lets the business owner know the minimum level of activity required to keep
the firm in operation.
127) Fixed expenses are those that do not vary with changes in the volume of sales, but do vary
with production.
128) On a break-even chart, the break-even point occurs at the intersection of the fixed expense
line and the total revenue line.
129) Why is it important for an entrepreneur, about to launch a business, to perform a break-even
analysis? Describe the steps in calculating it.
130) Explain the procedure for constructing a graph that visually portrays the firm's break-even
point (the point where revenues equal expenses).
131) What are the advantages and the disadvantages of using break-even analysis?
Mini-Case 12-1: 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.
132) 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?
133) Help Jim compute the break-even point for his brake service.
Mini-Case 12-3: 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.
134) What level of sales would Birmingham's have to achieve if it wanted to make a $25,000
profit?
135) Construct a break-even chart for Birmingham's.
136) Compute a break-even point in dollars.
137) Suppose that the manufacturer desires a profit of $9,000 on this product. How many units
must be sold?
Mini-Case 12-6: 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
138) Calculate Harry's break-even point.
139) Create a break-even chart for Harry.
140) If Harry's profit target is $15,000, what level of sales must be achieved?
