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SOLUTION
(15 min.) Contribution margin, decision making.
1. Revenues $600,000
Deduct variable costs:
2. Contribution margin percentage =
$198,000
$600,000
= 33%
3. Incremental revenue (25% × $600,000) = $150,000
Incremental contribution margin
(33% × $150,000) $49,500
If Mr. Welch spends $8,000 more on advertising, the operating income will increase by
$41,500, changing the operating loss of $(9,000) to an operating profit of $32,500 ($41,500 −
$9,000).
Proof (Optional):
Operating costs:
Salaries and wages $140,000
Sales commissions (12% of sales) 90,000
Depreciation of equipment and fixtures 10,000
Store rent 42,000
Other operating costs:
$30,000 $750, 000
$600,000
æ ö
´
ç ÷
è ø
Fixed 15,000 342,500
Operating income $ 32,500
4. To improve operating income, Mr. Wharton must find ways to decrease variable costs,
3-36 Contribution margin, gross margin, and margin of safety. Juicy
Beauty manufactures and sells a face cream to small specialty stores in the greater Los Angeles
area. It presents the monthly operating income statement shown here to George Lopez, a
potential investor in the business. Help Mr. Lopez understand Juicy Beauty’s cost structure.
Required:
1. Recast the income statement to emphasize contribution margin.
2. Calculate the contribution margin percentage and breakeven point in units and revenues
for June 2017.
3. What is the margin of safety (in units) for June 2017?
4. If sales in June were only 16,000 units and Juicy Beauty’s tax rate is 30%, calculate its net
income.
SOLUTION
(20 min.) Contribution margin, gross margin and margin of safety.
1.
Juicy Beauty
Operating Income Statement, June 2017
Units sold 20,000
Variable costs
Variable manufacturing costs $ 110,000
Contribution margin 80,000
Fixed costs
Fixed manufacturing costs $ 40,000
Fixed marketing & administration costs 20,000
1.
Contribution margin per unit =
$80,000 $4 per unit
20,000 units =
Breakeven quantity =
Fixed costs $60, 000 15,000 units
Contribution margin per unit $4 per unit
= =
Selling price =
Revenues $200,000 $10 per unit
Units sold 20,000 units
= =
´
Alternatively,
Contribution margin percentage =
Contribution margin $80, 000 40%
Revenues $200, 000
= =
Breakeven revenues =
Fixed costs $60,000 $150,000
Contribution margin percentage 0.40
= =
2. Margin of safety (in units) = Units sold – Breakeven quantity
4. Units sold 16,000
3-37 Uncertainty and expected costs. Kindmart is an international retail store. Kindmart’s
managers are considering implementing a new business-to-business (B2B) information system
for processing merchandise orders. The current system costs Kindmart $2,000,000 per month and
$55 per order. Kindmart has two options, a partially automated B2B and a fully automated B2B
system. The partially automated B2B system will have a fixed cost of $6,000,000 per month and
a variable cost of $45 per order. The fully automated B2B system has a fixed cost of $14,000,000
per month and a variable cost of $25 per order.
Based on data from the past two years, Kindmart has determined the following distribution
on monthly orders:
Required:
1. Prepare a table showing the cost of each plan for each quantity of monthly orders.
2. What is the expected cost of each plan?
3. In addition to the information system’s costs, what other factors should Kindmart consider
before deciding to implement a new B2B system?
SOLUTION
(30 min.) Uncertainty and expected costs.
1. Monthly Number of Orders Cost of Current System
300,000 $2,000,000 + $55(300,000) = $18,500,000
Monthly Number of Orders Cost of Partially Automated System
300,000 $6,000,000 + $45(300,000) = $19,500,000
Monthly Number of Orders Cost of Fully Automated System
300,000 $14,000,000 + $25(300,000) = $21,500,000
2.
Current System Expected Cost:
$18,500,000 × 0.25 = $ 4,625,000
$30 ,050,000
Partially Automated System Expected Cost:
$19,500,000 × 0.25 = $ 4,875,000
$28 ,950,000
Fully Automated System Expected Cost:
3. The fully automated system has the lowest expected cost. Before making a final deision,
Kindmart should consider the impact of the different systems on its relationship with suppliers.
3-38 CVP analysis, service firm. Lifetime Escapes generates average revenue of $7,500 per
person on its 5-day package tours to wildlife parks in Kenya. The variable costs per person are as
follows:
Annual fixed costs total $570,000.
Required:
1. Calculate the number of package tours that must be sold to break even.
2. Calculate the revenue needed to earn a target operating income of $102,000.
3. If fixed costs increase by $19,000, what decrease in variable cost per person must be
achieved to maintain the breakeven p oint calculated in requirement 1?
4. The general manager at Lifetime Escapes proposes to increase the price of the package tour
to $8,200 to decrease the breakeven point in units. Using information in the original problem,
calculate the new breakeven point in units. What factors should the general manager consider
before deciding to increase the price of the package tour?
SOLUTION
(15–20 min.) CVP analysis, service firm.
1. Revenue per package $7,500
$570,000
$1,200 per package
2. Contribution margin ratio =
price Selling
packageper margin on Contributi
=
$1, 200
$7,500
= 16%
3-39 CVP, target operating income, service firm. Spotted Turtle provides daycare for children
Mondays through Fridays. Its monthly variable costs per child are as follows:
Spotted Turtle charges each parent $640 per child per month.
Required:
1. Calculate the breakeven point.
2. Spotted Turtle’s target operating income is $10,800 per month. Compute the number of
children who must be enrolled to achieve the target operating income.
3. Spotted Turtle lost its lease and had to move to another building. Monthly rent for the new
building is $3,500. In addition, at the suggestion of parents, Spotted Turtle plans to take
children on field trips. Monthly costs of the field trips are $2,500. By how much should
Spotted Turtle increase fees per child to meet the target operating income of $10,800 per
month, assuming the same number of children as in requirement 2?
SOLUTION
(30 min.) CVP, target operating income, service firm.
1. Revenue per child $640
Variable costs per child 240
Contribution margin per child $400
$4,800
$400
2. Target quantity =
childper margin on Contributi
income operatingTarget costs Fixed
$4,800 $10,800
$400
+
3. Increase in rent ($3,500 – $2,100) $1,400
Field trips 2,500
3-40 CVP analysis, margin of safety. Marketing Docs prepares marketing plans for growing
businesses. For 2017, budgeted revenues are $1,500,000 based on 500 marketing plans at an
average rate per plan of $3,000. The company would like to achieve a margin of safety
percentage of at least 45%. The company’s current fixed costs are $400,000 and variable costs
average $2,000 per marketing plan. (Consider each of the following separately.)
Required:
1. Calculate Marketing Docs’ breakeven point and margin of safety in units.
2. Which of the following changes would help Marketing Docs achieve its desired margin of
safety?
a. The average revenue per customer increases to $4,000.
b. The planned number of marketing plans prepared increases by 5%.
c. Marketing Docs purchases new software that results in a 5% increase to fixed costs but
reduces variable costs by 10% per marketing plan.
SOLUTION
CVP analysis, margin of safety.
1.
Selling price $3,000
2a. Increase selling price to $4,000
Selling price $4,000
Variable costs per unit: 2 ,000
2b.
Selling price $3,000
2c.
Selling price $3,000
3-41 CVP analysis, income taxes. (CMA, adapted) J.T. Brooks and Company, a manufacturer
of quality handmade walnut bowls, has had a steady growth in sales for the past 5 years.
However, increased competition has led Mr. Brooks, the president, to believe that an aggressive
marketing campaign will be necessary next year to maintain the company’s present growth. To
prepare for next year’s marketing campaign, the company’s controller has prepared and
presented Mr. Brooks with the following data for the current year, 2017:
Required:
1. What is the projected net income for 2017?
2. What is the breakeven point in units for 2017?
3. Mr. Brooks has set the revenue target for 2018 at a level of $875,000 (or 25,000 bowls). He
believes an additional marketing cost of $16,500 for advertising in 2018, with all other costs
remaining constant, will be necessary to attain the revenue target. What is the net income for
2018 if the additional $16,500 is spent and the revenue target is met?
4. What is the breakeven point in revenues for 2018 if the additional $16,500 is spent for
advertising?
5. If the additional $16,500 is spent, what are the required 2018 revenues for 2018 net income
to equal 2017 net income?
6. At a sales level of 25,000 units, what maximum amount can be spent on advertising if a 2018
net income of $108,450 is desired?
