Chapter 7, Cost-Volume-Profit...

1. The following is Arkadia Corporation's contribution format income statement for last month:

Sales $1,200,000
Less: Variable Expenses $ 800,000
Contribution Margin $ 400,000
Less: Fixed Expenses $ 300,000
Net Income $ 100,000

The company has no beginning or ending inventories and produced and sold 20,000 units during the
month.

Required:
a) What is the company's contribution margin ratio?
b) What is the company's break-even in units?
c) If sales increase by 100 units, by how much should net income increase?
d) How many units would the company have to sell to attain target profits of $125,000?
e) What is the company's margin of safety in dollars?
f) What is the company's degree of operating leverage?

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Ans:

Difficulty: Easy

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2. Spencer Company's most recent monthly contribution format income statement is given below:

Sales $60,000
Less: Variable Expenses $45,000
Contribution Margin $15,000
Less: Fixed Expenses $18,000
Net Loss ($ 3,000)

The company sells its only product for $10 per unit. There were no beginning or ending inventories.

Required:
a) What are total sales in dollars at the break-even point?
b) What are total variable expenses at the break-even point?
c) What is the company's contribution margin ratio?
d) If unit sales were increased by 10% and fixed expenses were reduced by $2,000, what would be the
company's expected net income? (Prepare a new income statement.)
Ans: a) The contribution margin ratio is $15,000 / $60,000 = 25%. Therefore, the break-even in sales dollars
is $18,000 / 25% = $72,000.

b) The variable cost ratio is $45,000 / $60,000 = 75%. Therefore, the variable expenses at the break-
even point are $72,000 x 75% = $54,000.

c) 25%. See answer a) above.

d)
Sales ($60,000 x 1.1) $66,000
Less: Variable Expenses ($45,000 x 1.1) $49,500
Contribution Margin $16,500
Less: Fixed Expenses ($18,000 - $2,000) $16,000
Net Income $ 500
Difficulty: Medium

Difficulty: Hard

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3. Tanner Company's most recent contribution format income statement is presented below:

Sales $75,000
Less: Variable Expenses $45,000
Contribution Margin $30,000
Less: Fixed Expenses $36,000
Net Loss $(6,000)

The company sells its only product for $15 per unit. There were no beginning or ending inventories.

Required:
a) Compute the company's break-even point in units sold.
b) Compute the total variable expenses at the break-even point.
c) How many units would have to be sold to earn a target profit of $9,000?
d) The sales manager is convinced that a $6,000 increase in the advertising budget would increase total
sales by $25,000. Would you advise the increased advertising outlay?
Ans: a) Contribution margin ratio = $30,000 / $75,000 = 0.40
$36,000 / 0.40 = $90,000 break-even sales
$90,000 / $15 = 6,000 units to break even

b) Variable expense ratio = $45,000 / $75,000 = 0.60

$90,000 sales x 60% variable expense ratio = $54,000

c) ($36,000 + $9,000) / 0.40 = $112,500

$112,500 / $15 = 7,500 units

Yes, the advertising budget should be increased.

Difficulty: Medium

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4. Seco Corp., a wholesale supply company, uses independent sales agents to market the company's
products. These agents currently receive a commission of 20% of sales, but are demanding an increase
to 25% of sales. Seco had already prepared its budget for next year before learning of the sales agents'
demand for an increase in commissions. That budgeted income statement appears below:

Seco is considering the possibility of employing its own salespersons. Three individuals would be
required, at a salary of $30,000 each, plus commissions of 5% of sales. In addition, a sales manager
would be employed at a fixed annual salary of $160,000.

Required:
a) Compute Seco's break-even point in sales dollars based upon the company's budgeted income
statement, assuming that the company continues to use independent sales agents and that they are paid
the old commission rate of 20% of sales.
b) Compute Seco's break-even point in sales dollars, assuming that the company employs its own
salespersons.
c) Compute the sales dollars required to attain the target profit of $1,900,000, assuming that the
company continues to use independent sales agents and the company agrees to their demand for a 25%
sales commission.
d) Compute the sales dollars that would be required to generate the same net income, whether Seco
employs its own salespersons or continues to use the independent sales agents and pays them a 25%
commission.
Ans: a) Estimated break-even based on the budgeted income statement:

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b) Estimated break-even with company employing its own salespersons:

c) Estimated sales volume yielding target profit of $1,900,000:

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d) Estimated sales volume to attain the same profit, whether the company employs its own salespersons
or continues to use the sales agents and pays them a commission of 25%:

Profit = Sales - Variable expenses - Fixed expenses

Let X = sales volume

With sales agents:

Profit = X - 0.85X - $100,000

With salespersons:
Profit = X - 0.65X - $350,000

Profit will be the same when:

X - 0.85X - $100,000 = X - 0.65X - $350,000
$250,000 = 0.20X
X = $250,000 / 0.20 = $1,250,000

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5. Rawlings Company prepared the following budget information for the coming year:

The budget assumes the sale of 20,000 units of A, 100,000 units of B, and 80,000 units of C.

Required:
a) What is the company's break-even point given the sales mix above?
b) If the budgeted sales mix is maintained, what is the total contribution margin and net income if
300,000 units are sold?

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Ans: a)

b) Per unit contribution margins for Products A, B, and C:

Product A: $60,000 / 20,000 units = $3 per unit.

Product B: $200,000 / 100,000 units = $2 per unit.
Product C: $80,000 / 80,000 units = $1 per unit.

Product mix for Products A, B, and C:

Product A: 20,000 / (20,000 + 100,000 + 80,000) = 10%

Product B: 100,000  (20,000 + 100,000 + 80,000) = 50%
Product C: 80,000  (20,000 + 100,000 + 80,000) = 40%

Total contribution margin at 300,000 units:

Product A: 10% x 300,000 units x $3/unit = $ 90,000

Product B: 50% x 300,000 units x $2/unit = $300,000
Product C: 40% x 300,000 units x $1/unit = $120,000
Total Contribution Margin at 300,000 Units $510,000
Fixed Expenses $255,000
Net Income $255,000
Difficulty: Hard

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6. The following monthly budgeted data are available for the International Company:

Budgeted net income for the month is $220,000.

Required:
a) Calculate the break-even sales for the month.
b) Calculate the margin of safety.
c) Calculate the degree of operating leverage.
Ans: a) Break-even sales

Difficulty: Hard

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7. The following monthly budgeted data is available for the Baxter Company:

Budgeted net income for the month is $260,000.

Required:
a) Calculate the break-even sales for the month.
b) Calculate the margin of safety.
c) Calculate the degree of operating leverage.
Ans: a) Break-even sales

Difficulty: Hard

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8. Belli-Pitt, Inc produces a single product. The results of the company's operations for a typical month
are summarized in contribution format as follows:

Sales $540,000
Less: Variable Expenses $360,000
Contribution Margin $180,000
Less: Fixed Expenses $120,000
Net Income $ 60,000

The company produced and sold 120,000 kilograms of product during the month. There were no
beginning or ending inventories.

Required:
a) Given the present situation, compute
1. The break-even sales in kilograms.
2. The break-even sales in dollars.
3. The sales in kilograms that would be required to produce net income of $90,000.
4. The margin of safety in dollars.
b) An important part of processing is performed by a machine that is currently being leased for $20,000
per month. Belli-Pitt has been offered an arrangement whereby it would pay $0.10 royalty per kilogram
processed by the machine rather than the monthly lease.
1. Should the company choose the lease or the royalty plan?
2. Under the royalty plan, compute the break-even point in kilograms.
3. Under the royalty plan, compute the break-even point in dollars.
4. Under the royalty plan, determine the sales in kilograms that would be required to produce net
income of $90,000.

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Ans: a)

1. Sales = Variable expenses + Fixed expenses + Target profit

$4.50Q = $3.00Q + $120,000 + $0
$1.50Q = $120,000
Q = $120,000 / $1.50 = 80,000 units

2. 80,000 units x $4.50 = $360,000

3. Sales = Variable expenses + Fixed expenses + Target profit

$4.50Q = $3.00Q + $120,000 + $90,000
$1.50Q = $210,000
Q = $210,000 / $1.50 = 140,000 units

4. Margin of safety = Sales - Sales at break-even

= $540,000 - $360,000
= $180,000

b)

1. Since net income increases by $8,000, the royalty is a good plan, provided sales remains at the
same level.

2. Sales = Variable expenses + Fixed expenses + Target profit

$4.50Q = $3.10Q + $100,000 + $0
$1.40Q = $100,000
Q = $100,000 / $1.40 = 71,429 units

3. 71,429 x $4.50 = $321,429

4. Sales = Variable expenses + Fixed expenses + Target profit

$4.50Q = $3.10Q + $100,000 + $90,000
$1.40Q = $190,000
Q = $190,000 / $1.40 = 135,714 units

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Difficulty: Medium

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