Module 01 Assignment Overview In this class we will be discussing the basic foundations of marketing. Your weekly class project is to apply each of our weekly marketing components to be used for your

Contribution margin per unit is the dif ference between selling price and variable cost per unit. Contribution -margin percentage is the contribution margin per unit divided by selling price. 3-5 Describe three methods that managers can use to express CVP relationships. Three methods to express CVP relationships are the equation method, the contribution margin method, and the graph method. The first two methods are most useful for analyzing operating income at a few specific levels of sales. The graph method is useful for visualizing the effect of sales on operating income over a wide range of quantities sold. 3-6 Differentiate between breakeven analysis and CVP analysis. Breakeven analysis is about determining the value or the volume of sale at which the total revenues equal total costs, while CVP analysis goes beyond the breakeven analysis and explains the overall relationship between cost, volume, and profit, and their behaviors in relation to each other. 3-7 With regard to making decisions, what do you think are the main limitations of CVP analysis? Explain. The CVP analysis is based on a simple assumption that focuses only on two factors: revenue and cost. It assumes that the relationship between revenue and cost is linear. CVP analysis is applicable within a relevant range of activity and it is assumed that productivity and efficiency of operations will remain constant. CVP analysis also assumes that costs can be accurately divided into fixed and variable categories and selling price and variable cost per unit remain constant while these a ssumptions may not be true. CVP is limited in terms of the details and the amount of information that it can provide, especially in a multi -product operation. 3-8 How does an increase in the income tax rate affect the breakeven point? An increase in the income tax rate does not affect the breakeven point. Operating income at the breakeven point is zero, and no income taxes are paid at this point. 3-9 Describe sensitivity analysis. How has the advent of the electronic spreadsheet affected the use of sens itivity analysis? Sensitivity analysis is a ―what -if‖ technique that managers use to examine how an outcome will change if the original predicted data are not achieved or if an underlying assumption changes.

The advent of the electronic spreadsheet has gr eatly increased the ability to explore the effect of alternative assumptions at minimal cost. CVP is one of the most widely used software applications in the management accounting area. 3-10 Is CVP analysis more focused on the short or the long term? Expl ain. The CVP analysis is more focused on the short run because the variables cannot be influenced (fixed costs, selling price, and variable costs per unit). So the only variable that can be altered is the production and sales volume. EA 3-3 3-11 Is it possible t o calculate the breakeven point for a company that produces and sells more than one type of product? Explain. Yes. You can use the assumption of a constant sales mix of the products. You cannot calculate the BEP in products, but you can calculate the BEP in dollars revenue. 3-12 What is operating leverage? How is knowing the degree of operating leverage helpful to managers? Operating leverage describes the effects that fixed costs have on changes in operating income as changes occur in units sold, and he nce, in contribution margin. Knowing the degree of operating leverage at a given level of sales helps managers calculate the effect of fluctuations in sales on operating incomes. 3-13 CVP analysis assumes that costs can be accurately divided into fixed a nd variable categories. Do you agree? Explain. CVP analysis is always performed within a relevant range of activity and for a specified time horizon. What we consider to be a fixed cost in CVP analysis can be true when we are focusing on a specific short horizon, but it may not be true when it sufficient time is provided. In other words, a fixed cost in a short horizon can be considered as unfixed in a long -term horizon. Furthermore, there are some costs that are semi -fixed and some that are semi -variable, depending on the relevant range of activities. So the time periods and the relevant range of activities are two main bases for sort costs into the fixed and variable categories. 3-14 Give an example each of how a manager can decrease variable costs whi le increasing fixed costs and increase variable costs while decreasing fixed costs. Examples of decreasing variable costs and increasing fixed costs include: Manufacturing –– substituting a robotic machine for hourly wage workers Marketing –– changing a sales force compensation plan from a percent of sales dollars to a fixed salary Customer service –– hiring a subcontractor to do customer repair visits on an annual retainer basis rather than a per -visit basis Examples of decreasing fixed costs and increasing va riable costs include: Manufacturing –– subcontracting a component to a supplier on a per -unit basis to avoid purchasing a machine with a high fixed depreciation cost Marketing –– changing a sales compensation plan from a fixed salary to percent of sales dollar s basis Customer service –– hiring a subcontractor to do customer service on a per -visit basis rather than an annual retainer basis 3-15 What is the main difference between gross margin and contribution margin? Which one is the main focus of CVP analysis? E xplain briefly. EA 3-4 The gross margin focuses on full cost, but the contribution margin focuses only on variable cost to measures how much a company is making for its products above the costs of acquiring or producing them. The contribution margin is the main focus of CVP analysis. 3-16 Jack’s Jax has total fixed costs of $25,000. If the company’s contribution margin is 60%, the income tax rate is 25% and the selling price of a box of Jax is $20, how many boxes of Jax would the company need to sell to prod uce a net income of $15,000? a. 5,625 b. 4,445 c. 3,750 d. 3,333 SOLUTION Choice "c" is correct. The number of boxes needed to be sold is calculated as follows: Selling Price per box : $20 per box Contribution % = 60% Contribution margin per box : 60% × $20 = $12 per box Fixed costs : $25,000 Income after tax : $15,000 Tax rate : 25% Operating income before tax: $15,000 ÷ (1 – 0.25) = $15,000 ÷ 0.75 = $20,000 Total fixed costs $25,000 + target operating income, $20,000 = $45,000 Boxes necessary to produc e target operating income : $45,000 / $12 per box = 3,750 boxes Choice "a" is incorrect. The contribution margin of 60% means that variable costs are 40% of the sale price, not 60% of the sales price. Choice "b" is incorrect. The contribution margin needs to cover the fixed costs of $25,000 and the operating income before tax of $20,000. Fixed costs are not subject to the income tax rate in the calculation. Choice "d" is incorrect. Net income of $15,000 is after deducting the income tax expense. Operating income before tax of $20,000 must be generated in order to produce net income of $15,000. 3-17 During the current year, XYZ Company increased its variable SG&A expenses while keeping fixed SG&A expenses the same. As a result, XYZ’s: a. Contribution margin a nd gross margin will be lower. b. Contribution margin will be higher, while its gross margin will remain the same. c. Operating income will be the same under both the financial accounting income statement and contribution income statement. d. Inventory amo unts booked under the financial accounting income statement will be lower than under the contribution income statement. SOLUTION EA 3-5 Choice "c" is correct. Operating income is the bottom line figure under both the financial accounting income approach and the contribution margin approach. Both methods take SG&A (fixed and variable) into account, which means both will produce the same bottom line figure. Choice "a" is incorrect. The contribution margin will be lower due to an increase in variable SG&A expenses, but the gross margin (as calculated under the financial accounting income approach) will not be affected because fixed and variable SG&A expenses are deducted after calculating gross income. Choice "b" is incorrect. The gross margin will remain the same, as SG&A expenses do not factor into the gross margin calculation. The contribution margin will be lower (not higher) due to higher variable SG&A expenses. Choice "d" is incorrect. Inventory amounts will be the same under both methods, as SG&A expenses are period costs and will not affect inventory calculations. 3-18 Under the contribution income statement, a company’s contribution margin will be: a. Higher if fixed SG&A costs decrease. b. Higher if variable SG&A costs increase. c. Lower if fixed manufactu ring overhead costs decrease. d. Lower if variable manufacturing overhead costs increase. SOLUTION Choice "d" is correct. An increase in any variable costs will cause the contribution margin to be lower, as the contribution margin is calculated by taking sales and subtracting variable cost of goods sold (which includes variable overhead costs) and variable SG&A costs. Choice "a" is incorrect. Fixed SG&A costs do not factor into the contribution margin calculation. Choice "b" is incorrect. An increase in variable SG&A costs will decrease (rather than increase) the contribution margin. Choice "c" is incorrect. Fixed overhead costs do not factor into the contribution margin calculation. 3-19 A company needs to sell 10,000 units of its only product in order t o break even. Fixed costs are $110,000, and the per unit selling price and variable costs are $20 and $9, respectively.

If total sales are $220,000, the company’s margin of safety will be equal to: a. $0 b. $20,000 c. $110,000 d. $200,000 SOLUTION Choice "b" is correct. The margin of safety is equal to total actual sales − breakeven sales dollars. Since the breakeven number of unit sales is 10,000, and the sale price is $20, breakeven sales dollars equal s $200,000 ($20 per unit × 10,000 units) . The margin of safety is therefore $220,000 − $200,000 = $20,000. Choice "a" is incorrect. There is no margin of safety when total sales are equal to breakeven sales, which would be the case here if total sales were equal to $200,000. Choice "c" is incorrect. The mar gin of safety is incorrectly calculated here as total sales − fixed costs. EA 3-6 Choice "d" is incorrect. This answer choice is equal to breakeven sales dollars, not the margin of safety. 3-20 Once a company exceeds its breakeven level, operating income can be calculated by multiplying: a. The sales price by unit sales in excess of breakeven units. b. Unit sales by the difference between the sales price and fixed cost per unit. c. The contribution margin ratio by the difference between unit sales and breakeven sales. d. The contribution margin per unit by the difference between unit sales and breakeven sales. SOLUTION Choice "d" is correct. The contribution margin per unit represents the difference between sales price and variable cost per unit. Once breakeven has been met, a company has recovered its fixed and variable costs. Any sales in excess of breakeven sales will result in operating income equal to the contribution margin per unit multiplied by the excess in unit sales above breakeven sales. Choice "a" is incorrect. This equation does not take into account the variable costs per unit that will still be incurred with additional sales above breakeven. Choice "b" is incorrect. This will not eqaul the operating income earned when sales are in excess of breake ven. Choice "c" is incorrect. The contribution margin per unit (rather than the ratio) must be multiplied by the difference between unit sales and breakeven sales in order to calculate the profit. 3-21 CVP computations. Fill in the blanks for each of the following independent cases. SOLUTION (10 min.) CVP computations. Variable Fixed Total Operating Contribution Operating Contribution Revenues Costs Costs Costs Income Margin Income % Margin % a. $4,250 $1,700 $1,800 $3,500 $1,275 $2,550 30.00% 60.00% b. 8,000 5,000 1,000 6,000 2,000 3,000 25.00% 37.50% c. 6600 3500 900 4400 2200 3,100 33.33% 46.97% d. 7,400 2,400 1800 4,200 3,200 5,000 43.24% 67.57% EA 3-7 3-22 CVP computations. Simplex Inc. sells its product at $80 per unit with a contribution margin of 40%. During 2016, Simplex sold 540,000 units of its product; its total fixed costs are $2,100,000. Required : 1. Calculate (a) the total contribution margin, (b) the total variable costs, and (c) the overall operating income. 2. The production manager o f Simplex has proposed modernizing the whole production process in order to save labor costs. However, the modernization of the production process will increase the annual fixed costs by $3,800,000. The variable costs are expected to decrease by 20%. Simpl ex expects to maintain the same sales volume and selling price next year. How would the acceptance of the production manager’s proposal affect your answers to (a) and (c) in requirement 1? 3. Should Simplex accept the production manager’s proposal? Explain. SOLUTION (10 –15 min.) CVP computations. 1a. Contribution margin $ 17,280,000 ($80 per unit× 40% × 540,000 units) 1b. Sales ($80 per unit × 540,000 units) $43,200,000 Contribution margin (from above) 17,280,000 Variable costs $25,920,000 1c. Contribution margin (from above) $17,280,000 Fixed costs 2,100,000 Operating income $15,180,000 2a. Sales (from above) $43,200,000 Variable costs ($25,920,000 × 80%) 20,736,000 Contribution margin $22,464,000 2b. Contribution margin (from ab ove) $22,464,000 Fixed costs ($2,100,000 + 3,800,000) 5,900,000 Operating income $16,564,000 3. If the production manager’s proposal is accepted, the operating income is expected to increase by $1,384,000 ($16,564,000 − $15,180,000). The management wo uld consider other factors before making the final decision. It is likely that product quality will improve as a result of the modernized production process. However, due to increased automation, many workers will probably have to be laid off. Simplex’s ma nagement will have to consider the impact of such an action on employee morale. In EA 3-8 addition, the proposal increases the company’s fixed costs dramatically. This will increase the company’s operating leverage and risk. 3-23 CVP analysis, changing revenues and costs. Brilliant Travel Agency specializes in flights between Toronto and Vishakhapatnam. It books passengers on EastWest Air. Brilliant’s fixed costs are $36,000 per month. EastWest Air charges passengers $1,300 per round -trip ticket. Calculate the number of tickets Brilliant must sell each month to (a) break even and (b) make a target operating income of $12,000 per month in each of the following independent cases. Required : 1. Brilliant’s variable costs are $34 per ticket. EastWest Air pays Brilliant 10% commission on ticket price. 2. Brilliant’s variable costs are $30 per ticket. EastWest Air pays Brilliant 10% commission on ticket price. 3. Brilliant’s variable costs are $30 per ticket. EastWest Air pays $46 fixed commission per ticket to Brilliant. Com ment on the results. 4. Brilliant’s variable costs are $30 per ticket. It receives $46 commission per ticket from EastWest Air. It charges its customers a delivery fee of $8 per ticket. Comment on the results. SOLUTION (35 –40 min.) CVP analysis, changing re venues and costs. 1a. SP = 10% × $1,300 = $130 per ticket VCU = $34 per ticket CMU = $130 – $34 = $96 per ticket FC = $36,000 a month Q = = = 375 tickets 1b. Q = = = = 500 tickets 2a. SP = $130 per ticket VCU = $30 per ticket CMU = $130 – $30 = $100 per ticket CM U FC $36,000 $96 per ticket CM U TOI FC  $36,000 $12,000 $96 per ticket  $48,000 $96 per ticket EA 3-9 FC = $36,000 a month Q = = = 360 tickets 2b. Q = = = = 480 tickets 3a. SP = $46 per ticket VCU = $30 per ticket CMU = $46 – $30 = $16 per ticket FC = $36,000 a month Q = = = 2,250 tickets 3b. Q = = = = 3,000 tickets The reduced commission sizably increases the breakeven point and the number of tickets required to yie ld a target operating income of $12,000: 10% Commission Fixed (Requirement 2) Commission of $60 Breakeven point 360 2,250 Attain OI of $12,000 480 3,000 4a. The $8 delivery fee can be treated as either an extra source of revenue (as done below) or as a cost offset. Either approach increases CMU $8: SP = $54 ($46 + $8) per ticket CM U FC $36,000 $100 per ticket CM U TOI FC  $36,000 $12,000 $100 per ticket  $48,000 $100 per ticket CM U FC $36,000 $16 per ticket CM U TOI FC  $36,000 $12,000 $16 per ticket  $48,000 $16 per ticket EA 3-10 VCU = $30 per ticket CMU = $54 – $30 = $24 per ticket FC = $36,000 a month Q = = = 1,500 tick ets 4b. Q = = = = 2,000 tickets The $8 delivery fee results in a higher contribution margin, which reduces both the breakeven point and the tickets sold to attain operati ng income of $12,000. 3-24 CVP exercises. The Patisserie Hartog owns and operates 10 puff pastry outlets in and around Amsterdam. You are given the following corporate budget data for next year: Revenues $12,500,000 Fixed costs $ 2,240,000 Variable cost s $ 9,750,000 Variable costs change based on the number of puff pastries sold. Compute the budgeted operating income for each of the following deviations from the original budget data. (Consider each case independently.) Required : 1. A 15% increase in cont ribution margin, holding revenues constant 2. A 15% decrease in contribution margin, holding revenues constant 3. A 10% increase in fixed costs 4. A 10% decrease in fixed costs 5. A 12% increase in units sold 6. A 12% decrease in units sold 7. An 8% increase in fixed costs and an 8% increase in units sold 8. A 6% increase in fixed costs and a 6% decrease in variable costs 9. Which of these alternatives yields the highest budgeted operating income? Explain why this is the case. SOLUTION (20 min.) CVP exercises. CM U FC $36,000 $24 per ticket CM U TOI FC  $36,000 $12,000 $24 per ticket  $48,000 $24 per ticket EA 3-11 Revenues Varia ble Costs Contribution Margin Fixed Costs Budgeted Operating Income Orig . $12,500,000 G $9,750,000 G $2,750,000 $2,240,000 G $ 510,000 1. 12,500,000 9,750,000 3,162,500 a 2,240,000 922,500 2. 12,500,000 9,750, 000 2,337,500 b 2,240,000 97,500 3. 12,500,000 9,750,000 2,750,000 2,464,000 c 286,000 4. 12,500,000 9,750,000 2,750,000 2,016,000 d 734,000 5. 14,000,000 e 10,920,000 f 3,08 0,000 2,240,000 840,000 6. 11,000,000 g 8,580,000 h 2,420,000 2,240,000 180,000 7. 13,500,000 i 10,530,000 j 2,970,000 2,419,200 k 550,800 8. 12,500,000 9,165,000 l 3,335,000 2,374,400 m 960,600 Gstands for given. a$2,750,000 × 1.15 ; b $2,750,000 × 0.85; c$2,240,000 × 1.10; d$2,240,000 × 0.90; e$12,500,000 × 1.12; f$9,750,000 × 1.12; g$12,500,000 × 0.88; h$9,750,000 × 0.88; i$12,500,000 × 1.08; j$9,750,000 × 1.08; k$2,2 40,000 × 1.08; l$9,750,000 × 0.94; m$2,240,000 × 1.06 9. Alternative 8, an 8% decrease in variable costs holding revenues constant with a 6% increase in fixed costs, yields the highest budgeted operating income because it has decreased variables costs and consequently made a highest increase in the contribution margin which has contributed in the highest increase in operating income after nullifying the effect of increase in fixed costs. 3-25 The Unique Toys Company manufactures and sells toys . Currently, 300,000 units are sold per year at $ 12 .50 per unit. Fixed costs are $ 880 ,000 per year. Variable costs are $ 7.00 per unit. Consider each case separately: Required : 1. a. What is the current annual operating income? b. What is the present breakeven point in revenues? Compute the new operating income for each of the following changes: 2. A 10% increase in variable costs 3. A $250,000 increase in fixed costs an d a 2% increase in units sold 4. A 10 % decrease in fixed costs, a 10 % decrease in selling pric e, a 10 % increase in variable cost per unit, and a 25 % increase in units sold Compute the new breakeven point in units for each of the following changes: 5. A 20 % increase in fixed costs 6. A 12 % increase in selling price and a $ 30,000 increase in fixed costs SOLUTION (20 min.) CVP exercises. 1a. [Units sold (Selling price – Variable costs)] – Fixed costs = Operating income EA 3-12 [300,000 ($12.50 – $7.00)] – $880,000 = $770,000 1b. Fixed costs ÷ Contribution margin per unit = Breakeven units $880,000 ÷ [($12.50 – $7.00)] = 160,000 units Breakeven units × Selling price = Breakeven revenues 160,000 units × $12.50 per unit = $2,000,000 or, Contribution margin ratio = = = 0.4 4 = 44% Fixed costs ÷ Contribution margin ratio = Breakeven revenues $880,000 ÷ 0.44 = $2,000,000 2. 300,000 ($12.50 – $7.00 × 110%)) – $880,000 = $560,000 3. [300,000 (1.02) ($12.50 – $7.00)] – ($880,000 + 250,000)] = $2,813,000 4. [300,000 (1.25) ($11.25 – $7. 70)] – [$880,000 (0.9)] = $539,250 5. $880,000 (1.2) ÷ ($12.50 – $7.00) = 192,000 units 6. ($880,000 + $30,000) ÷ ($14.00 – $7.00) = 130,000 units 3-26 CVP analysis, income taxes. Sonix Electronics is a dealer of industrial refr igerator. Its average selling price of an industrial refrigerator is $5,000, which it purchases from the manufacturer for $4,200. Each month, Sonix Electronics pays $52,800 in rent and other office expenditures and $75,200 for salespeople’s salaries. In ad dition to their salaries, salespeople are paid a commission of 4% of sale price on each refrigerator they sell. Sonix Electronics also spends $18,400 each month for local advertisements. Its tax rate is 30%. Required : 1. How many refrigerators must Sonix Ele ctronics sell each month to break even? 2. Sonix Electronics has a target monthly net income of $63,000. What is its target monthly operating income? How many refrigerators must be sold each month to reach the target monthly net income of $63,000? SOLUTION (10 min.) CVP analysis, income taxes. 1. Monthly fixed costs = $52,800 + $75,200 + $18,400 = $146,400 Contribution margin per unit = $5,000 – $4,200 – $5,000 × .04 = $600 Breakeven units per month = = = 244 refrigerato rs 2. Tax rate 30% Target net income $65,000 p rice Selling costs Variable p rice Selling - $12.50 - $7.00 $12.50 EA 3-13 Target operating income = $90,000 Quantity of output required to be sold = = 394 refrigera tors 3-27 CVP analysis, income taxes. The Swift Meal has two restaurants that are open 24 hours a day. Fixed costs for the two restaurants together total $456,000 per year. Service varies from a cup of coffee to full meals. The average sales check per cus tomer is $9.50. The average cost of food and other variable costs for each customer is $3.80. The income tax rate is 30%. Target net income is $159,600. Required : 1. Compute the revenues needed to earn the target net income. 2. How many customers are needed to break even? To earn net income of $159,600? 3. Compute net income if the number of customers is 145,000. SOLUTION (20 –25 min.) CVP analysis, income taxes. 1. Variable cost percentage is $3.80  $9.50 = 40% Let R = Revenues needed to obtain target net income R – 0.40R – $456,000 = 0.60R = $456,000 + $228,000 R = $684,000  0.60 R = $1,140,000 or, Proof: Revenues $1,140,000 Variable costs ( at 40%) 456,000 Contribution margin 684,000 Fixed costs 456,000 Operating income 228,000 Income taxes (at 30%) 68,400 Net income $ 159,600 2.a. Customers needed to break even: Contribution margin per customer = $9.50 – $3 .80 = $5.70 Breakeven number of customers = Fixed costs  Contribution margin per customer Target net income $63, 000 $63, 000 1 tax rate (1 0.30) 0.70     $159, 600 1 0.30 Fixed costs + Target operating income Target revenues Contribution margin percentage  Target net income $159, 600 Fixed costs + $456, 000 1 Tax rate 1 0.30 Target revenues $1,140, 000 Contribution margin percentage 0.60      EA 3-14 = $456,000  $5.70 per customer = 80,000 customers 2.b. Customers needed to earn net income of $159,600: Total revenues  Sales check per customer $1,140,000  $9.50 = 120,000 customers 3. Using the shortcut approach: Change in net income = = (145,000 – 120,000)  $5.70  (1 – 0.30) = $142,500  0.7 = $99,750 New net income = $99,75 0 + $159,600 = $259,350 Alternatively, with 145,000 customers, Operating income = Number of customers  Selling price per customer – Number of customers  Variable cost per customer – Fixed costs = 145,000  $9.50 – 145,000  $3.80 – $456,000 = $370 ,500 Net income = Operating income × (1 – Tax rate) = $370,500 × 0.70 = $259,350 The alternative approach is: Revenues, 145,000  $9.50 $1,377,500 Variable costs at 40% 551,000 Contribution margin 826,500 Fixed costs 456,000 Oper ating income 370,500 Income tax at 30% 111,150 Net income $ 259,350 3-28 CVP analysis, sensitivity analysis. Roughstyle Shirts Co. sells shirts wholesale to major retailers across Australia. Each shirt has a selling price of $40 with $26 i n variable costs of goods sold. The company has fixed manufacturing costs of $1,600,000 and fixed marketing costs of $650,000. Sales commissions are paid to the wholesale sales reps at 10% of revenues. The company has an income tax rate of 30%. Required : 1. How many shirts must Roughstyle sell in order to break even? 2. How many shirts must it sell in order to reach: a. a target operating income of $600,000? b. a net income of $600,000? 3. How many shirts would Roughstyle have to sell to earn the net income in par t 2b if: (Consider each requirement independently.) a. the contribution margin per unit increases by 15%. b. the selling price is increased to $45.00. c. the company outsources manufacturing to an overseas company increasing variable costs per unit by $3.00 and saving 50% of fixed manufacturing costs .   Change in Unit number of contribution 1 Tax rate customers margin                   EA 3-15 SOLUTION CVP analysis, sensitivity analysis. 1. CMU = $40−$26−(0.1 × $40) = $10.00 Q = = = 225,000 shirts Note: No income taxes are paid at the breakev en point because operating income is $0. 2a. Q = = = = 285,000 shirts 2b. Target operating income = = $857,143 (rounded) = = 310,714 shirts (rounded) 3a. Contribution margin per unit increases by 15% Contribution margin per unit = $10 × 1.15 = $11.5 = = 270,186 shirts (rounded) The net income target in units decreases from 310,714 shirts in requirement 2b to 270,186 shirts. 3b. Increasing the selling price to $45.00 Contribution margin per unit = $45 − $26 − (0.1 × $45) = $14.5 = CM U FC $2,250,000 $10 per shirt CM U TOI FC  $2,250,000 $600,000 $10 per shirt  $2,850,000 $10 per shirt Target net income $600, 000 $600, 000 1 tax rate (1 0.3) 0.7   Quantity of output units required to be sold Fixed costs + Target operating income $2, 250, 000 $ Contribution margin pe 857 r ,1 unit 10 43 $   Quantity of output units required to be sold Fixed costs + Target operating income $2, 250, 000 $857,143 Contribution margin per unit $11.5   Quantity of output units required to be sold Fixed costs + Target operating income $2, 250, 000 $857,143 Contribution margin per unit $14.5   EA 3-16 = 214,286 shirts (rounded) The net income target in units decreases from 310,714 pieces in requirement 2b to 214,286 shirts. 3c. Increase variable costs by $3.00 per unit and decrease fixed manufactu ring costs by 50%. Contribution margin per unit = $40 – $29 ($26 + $3) – (0.1 × $40) = $7.00 Fixed manufacturing costs = (1 – 0.5) × $1,600,000 = $800,000 Fixed marketing costs = $650,000 Total fixed costs = $800,000 + $650,000 = $1,450,000 = = 329,592 shirts (rounded) The net income target in units increases from 310,714 shirts in requirement 2b to 329,592 shirts. 3-29 CVP analysis, margin of safety. Ariba Corporation reaches its breakeven point a t $3,200,000 of revenues. At present, it is selling 105,000 units and its variable costs are $30. Fixed manufacturing costs, administrative costs, and marketing costs are $400,000, $250,000, and $150,000 respectively. Required : 1. Compute the contribution ma rgin percentage. 2. Compute the selling price. 3. Compute the margin of safety in units and dollars. 4. What does this tell you about the risk of Ariba making a loss? What are the most likely reasons for this risk to increase? SOLUTION (10 min.) CVP analysis, m argin of safety. 1. Breakeven point revenues = Contribution margin percentage = 2. Contribution margin percentage = Quantity of output units required to be sold Fixed costs + Target operating income $ $8 57,143 Contribu 1, 450, 0 tion margin per unit $7 00   Fixed costs Contribution margin percentage (Fixed manufacturing costs + Fixed admin istrative costs + Fixed marketing costs) Breakeven point revenues ($400,000 + $250,000 + $150,000) $800,000 0.25 or 25% $3,200,000 $3,200,000     p rice Selling unit p er cost Variable p rice Selling  EA 3-17 0.25 = 0.25 SP = SP – $30 0.75 SP = $30 SP = $40 3. Breakeven sales in units = Breakeven revenues ÷ Selling price = $3,200,000 ÷ $40 = 80,000 units Margin of safety in units = Sales in units – Breakeven sales in units = 105,000 – 80,000 = 25,000 units Revenues, 105,000 units  $40 $4,200,000 Breakeven revenues 3,200,000 Margin of safety $1,000,000 The risk of making a loss is high. If due to adverse situations, sales decrease by 25,000 units ÷ 105,000 units i.e. by 23.81% or more, Ariba will make a loss. The most likely reasons for this risk are increased competition, entry of substitute products, sudden drop in demand due to economic condition, or bad management. 3-30 Operating leverage. Broadpull Rugs is holding a 4 -week carpet sale at Tryst’s Club, a local warehouse store. Broadpull Rugs plans to sell carpets for $1,500 each. The company will purchase the carpets from a local distributor for $900 each, with the privilege of returning any unsold units for a full refund. Tryst’s Club has offered Broadpull Rugs two payment alternatives for the use of space.  Option 1: 25% of total revenues earned during the sale period  Option 2: A fixed payment of $30,000 for the sale period Assume Broadpull Rugs will incur no othe r costs. Required : 1. Calculate the breakeven point in units for (a) option 1 and (b) option 2. 2. At what level of revenues will Broadpull Rugs earn the same operating income under either option? a. For what range of unit sales will Broadpull Rugs prefer optio n 1? b. For what range of unit sales will Broadpull Rugs prefer option 2? 3. Calculate the degree of operating leverage at sales of 80 units for the two rental options. 4. Briefly explain and interpret your answer to requirement 3. SOLUTION (25 min.) Operati ng leverage. 1a. Let Q denote the quantity of carpets sold Breakeven point under Option 1 $1,500Q  $900Q  (0.25  $1,500Q) = 0 225Q = 0 SP $30 SP  EA 3-18 Q = 0 1b. Breakeven point under Option 2 $1,500Q  $900Q = $30,000 $600Q = $30 ,000 Q = $30,000  $600 = 50 carpets 2. Operating income under Option 1 = $225Q Operating income under Option 2 = $600Q  $30,000 Find Q such that $225Q = $600Q  $30,000 Or $375Q = $30,000 Q = $30,000  $375 = 80 carpets Rev enues = $1,500 × 80 carpets = $120,000 For Q = 80 carpets, operating income under both Option 1 ($225 × 80) and Option 2 ($600 × 80  $30,000) = $18,000 For Q > 80, say, 81 carpets, Option 1 gives operating income = $225  81 = $18,225 Option 2 give s operating income = ($600  81)  $30,000 = $18,600 So Broadpull Rugs will prefer Option 2. For Q < 80, say, 79 carpets, Option 1 gives operating income = $225  79 = $17,775 Option 2 gives operating income = ($600  79)  $30,000 = $17,400 So Broadpull Rugs will prefer Option 1. 3. Degree of operating leverage = Under Option 1, contribution margin per unit = $1,500 – $900 – 0.25  $1,500 = $225, so Degree of operating leverage = = 1.0 Under Option 2, contribution margin per unit = $1,500 – $900 = $600, so Degree of operating leverage = = 2.67 (rounded) Contribution margin Operating income Contribution margin per unit Quantity o f carpets sold Operating income   $225 80 $18,000  $600 80 $18,000  EA 3-19 4. The calculations in requirement 3 indicate that when sales are 80 units, a perce ntage change in sales and contribution margin will result in 2.67 times that percentage change in operating income for Option 2, but the same percentage change in operating income for Option 1 (because there are no fixed costs in Option 1). The degree of o perating leverage at a given level of sales helps managers calculate the effect of fluctuations in sales on operating incomes. EA 3-20 3-31 CVP analysis, international cost structure differences. Plush Decor, Inc., is considering three possible countries for the sole manufacturing site of its newest area rug: Italy, Spain, and Singapore. All area rugs are to be sold to retail outlets in Australia for $200 per unit. These retail outlets add their own markup when selling to final customers. Fixed costs and variable cost per unit (area rug) differ in the three countries. Required: 1. Compute the breakeven point for Plush Decor, Inc., in each country in (a) units sold and (b) revenues. 2. If Plush Decor, Inc., plans to produce and sell 80,000 rugs in 2014, what is the budgeted operating income for each of the three manufacturing locations? Comment on the results. SOLUTION (15 min.) CVP analysis, international cost structure differences. Country (1) (2) (3) (4) (5) = (1) – (3) – (4) (6) = (2) (5) (6) (1) (7) = [80,000 (5)] – (2) Italy $200 $ 6,386,000 $70 $27 $103.00 62,000 $12,400,000 $1,854,000 Spain 200 5,043,000 61 16 123.00 41,000 8,200,000 4,797,000 Singapore 200 12,240,000 84 14 102.00 120,000 24,000,000 (4,080,000) Spain has the lowest breakeven point because it has both the lowest fixed costs ($5,043,000) and the lowest variable cost per unit ($77.00). Hence, for a given selling price, Spain will always have a higher operating income (or a lower operating loss) than Italy or Singapore. The Singapore breakeven point is 120,000 units. Hence, with sales of only 80,000 units, it has an operating loss of $4,080,000. 3-32 Sales mix, new and upgrade cus tomers. Chartz 1 -2-3 is a top -selling electronic spreadsheet product. Chartz is about to release version 5.0. It divides its customers into two groups: new customers and upgrade customers (those who previously purchased Chartz 1 -2-3 4.0 or earlier versions ). Although the same physical product is provided to each customer group, sizable differences exist in selling prices and variable marketing costs: Requirement 2 Requirement 1    EA 3-21 The fixed costs of Chartz 1 -2-3 5.0 are $16,500,000. The planned sales mix in units is 60% new customers and 40% upgrade customers. Required: 1. What is the Chartz 1 -2-3 5.0 breakeven point in units, assuming that the planned 60%40% sales mix is attained? 2. If the sales mix is attained, what is the operating income when 170,000 total units are sold? 3. Show how the breakeven point in units changes with the following customer mixes: a. New 40% and upgrade 60% b. New 80% and upgrade 20% c. Comment on the results. SOLUTION (30 min.) Sales mix, new and upgrade customers. 1. New Customers Upgrade Customers SP VCU CMU $195 65 $130 $115 35 $ 80 The 60%/40% sales mix implies that, in each bundle, 3 units are sold to new customers and 2 units are sold to upgrade customers. Contribution margin of the bundle = 3  $130 + 2  $80 = $ 390 + $ 160 = $ 550 Breakeven point in bundles = = 30 ,000 bundles Breakeven point in units is: Sales to new customers: 30 ,000 bundles 3 units per bundle  90 ,000 units  Sales to upgrade customers:  30 ,000 bundles 2 units per bundle  60 ,000 units  Total number of units to breakeven (rounded)  15 0,000 units   Alternatively,   Let S = Number of units sold to upgrade customers 1.5S = Number of units sold to new customers Revenues – Variable costs – Fixed costs = Operating income [$ 19 5 (1.5 S) + $ 115 S] – [$65 (1.5 S) + $ 35 S] – $1 6,500,000 = OI $407 .5S – $132.5 S – $1 6,5 00,000 = OI Breakeven point is 15 0,000 units when OI = $0 because $16, 500, 000 $550 EA 3-22 $275 S = $1 6,5 00,000 S = 60 ,000 units sold to upgrade customers 1.5 S = 90 ,000 units sold to new customers BEP = 150,000 units Check Revenues ($ 19 5  90 ,000 ) + ( $115  60 ,000 ) $2 4,45 0,000 Variable costs ($ 65  90 ,000 ) + ( $35  60 ,000 ) 7,950 ,00 0 Contribution margin 16,5 00,0 00 Fixed costs 16,5 00,000 Operating income $ 0 2. When 170 ,000 units are sold, mix is: Units sold to new customers (60%  170 ,000 ) 102,000 Units sold to upgrade customers (40%  170 ,000 ) 68,000 Revenues ($ 195  102,000 ) + ( $115  68,000 ) $27,71 0,000 Variable costs ($ 65  102,000 ) + ( $35  68,000 ) 9,010 ,000 Contribution margin 18,7 00,000 Fixed costs 16,5 00,000 Operating income $ 2,2 00,000 3a. At New 4 0%/U pgrade 6 0% mix, each bundle contains 2 unit s sold to new customer s and 3 unit s sold to upgrade customer s. Contr ibution margin of the bundle = 2  $130 + 3  $80 = $ 26 0 + $ 24 0 = $ 500 Breakeven point in bundles = = 3 3,000 bundles Breakeven point in units is: Sales to new customers: 33,000 bundles × 2 unit per bundle 66,000 units Sales to upgrade customers: 33,000 bundles × 3 unit per bundle 99,000 units Total number of units to breakeven 165 ,000 units Alternatively, Let S = Number of units sold to new customers then 1.5 S = Number of units sold to upgrade customers [$ 195 S + $115 (1.5 S)] – [$65 S + $35 (1.5 S)] – $1 6,500,000 = OI 367.5 S – 117.5 S = $16,5 00,000 250 S = $16,5 00,000 S = 66,000 units sold to new customers 1.5 S = 99,000 units sold to upgrade customers BEP = 165 ,000 units Check Revenues ($ 19 5  66,000 ) + ( $115  99,000) $24 ,255 ,000 Variable costs ($ 65  66,000 ) + ( $35  99,000) 7,755 ,000 Contribution margin 16,500,000 $16, 500, 000 $500 EA 3-23 Fixed costs 16,500,000 Operating income $ 0 3b. At New 80%/ Upgrade 2 0% mix, each bundle contains 4 units sold to new c ustomers and 1 unit sold to upgrade customer s. Contribution margin of the bundle = 4  $1 30 + 1  $80 = $ 52 0 + $ 80 = $60 0 Breakeven point in bundles = = 27,5 00 bundles Breakeven point in units is: Sales to new custo mers: 27,5 00 bundles 4units per bundle  11 0,000 units  Sales to upgrade customers:  27,5 00 bundles 1 unit per bundle  27,500 units  Total number of units to breakeven  137 ,500 units   Alternatively,   Let S = Number of units sold to upgrade customers then 4 S = Number of units sold to new customers [$ 19 5 (4S) + $ 115 S] – [$65 (4S) + $ 35 S] – $1 6,5 00,000 = OI 895 S – 295 S = $1 6,500,000 600S = $16 ,500,000 S = 27,500 units sold to upgrade customers 4S = 110 ,000 units sold to new customers 137,5 00 units Check Revenues ($ 195  11 0,000 ) + ( $1 15  27,500 ) $24, 612,5 00 Variable costs ($ 65  11 0,000 ) + ( $35  27 ,500 ) 8,112 ,000 Contribution margin 16,5 00,00 0 Fixed costs 16,5 00,000 Operating income $ 0 3c. As Chartz increase s its percentage of new customers, which have a higher contribution margin per unit than upgrade customers, the number of units required to break even decreases: New Customers Upgrade Customers Breakeven Point Requirement 3(a) Requirement 1 Requirement 3(b) 40% 60 80 60% 40 20 165 ,000 150,000 137 ,500 3-33 Sales mix, three products. The Belkin Company has three product lines of coffee mugs — A, B, and C — with contribution margins of $7, $5, and $4, respectively. The president foresees sales of 240,000 un its in the coming period, consisting of 40,000 units of A, 120,000 units of B, and 80,000 units of C. The company’s fixed costs for the period are $552,000. Required : 1. What is the company’s breakeven point in units, assuming that the given sales mix is mai ntained? $16, 500, 000 $600 EA 3-24 2. If the sales mix is maintained, what is the total contribution margin when 220,000 units are sold? What is the operating income? 3. What would operating income be if the company sold 40,000 units of A, 100,000 units of B, and 100,000 units of C? What is the new breakeven point in units if these relationships persist in the next period? 4. Comparing the breakeven points in requirements 1 and 3, is it always better for a company to choose the sales mix that yields the lower breakeven point? Explain. SOLUT ION (15 –25 min.) Sales mix, three products. 1. Sales of A, B, and C are in ratio 40,000 : 120,000 : 80,000. So for every 1 unit of A, 3 (120,000 ÷ 40,000) units of B are sold, and 2 (80,000 ÷ 40,000) units of C are sold. Contribution margin of the bundle = (1  $7) + (3  $5) + (2  $4) = $7 + $15 + $8 = $30 Breakeven point (in bundles) bundles Breakeven point in units is: Product A: 18,400 bundles × 1 unit per bundle 18,400 units Product B: 18,400 bundles × 3 units per bundle 55,200 units Product C: 18,400 bundles × 2 units per bundle 36,800 units Total number of units to breakeven 110,400 units Alternatively, Let Q = Number of units of A to break even 3Q = Number of units of B to break even 2Q = Number of uni ts of C to break even Contribution margin – Fixed costs = Zero operating income $7Q + $5(3Q) + $4(2Q) – $552,000 = 0 $30Q = $552,000 Q = 18,400 ($552,000 ÷ $30) units of A 3Q = 55,200 units of B 2Q = 36,800 units of C Total = 110,400 units 2. Calculate sales mix at 220,000 total units: A: 1/6 (or 40,000/240,000)  220,000 = 0.167; 0.167  220,000 = 36,740 units B: 3/6 (or 120,000/240,000)  220,000 = 0.5; 0.5  220,000 = 110,000 units C: 2/6 (or 80,000/240,000)  220, 000 = 0.333; 0.333  220,000 = 73,260 units Contribution margin: A: 36,740  $7 $257,180 B: 110,000  $5 550,000 C: 73,260  $4 293,040 EA 3-25 Contribution margin $1,100,220 Fixed costs 552,000 Operating income $548,220 3. Contributio n margin A: 40,000  $7 $280,000 B: 100,000  $5 500,000 C: 100,000  $4 400,000 Contribution margin $1,180,000 Fixed costs 552,000 Operating income $628,000 Sales of A, B, and C are in ratio 40,000 : 100,000 : 100,000. So for every 1 unit of A, 2.5 (1,000,000 ÷ 40,000) units of B and 2.5 (100,000 ÷ 40,000) units of C are sold, that is, for every 2 units of A, 5 units of B and 5 units Contribution margin of the bundle = (2  $7) + (5  $5) + (5  $4) = $14 + $25 + $20 = $59 Breakeven point in bundles = 552,000 / $59 = 9,356 bundles (rounded) Breakeven point in units is: Product A: 9,356 bundles 2 units per bundle  18,712 units  Product B:  9,356 bundles 5 units per bundle  46,780 units  Product C:  9,356 bundles 5 units per bundle  46,780 units  Total number of units to breakeven  112,272 units    Alternatively,   Let 2Q = Number of units of A to break even   5Q  = Number of units of B to break even   5Q  = Number of units o f C to break even    Contribution margin – Fixed costs = Breakeven point $7(2Q) + $5(5Q) + $4(5Q) – $552,000 = 0 $59Q = $552,000 2Q = 18,712 [($552,000 ÷ $59)  2] units of A 5Q = 46,780 units of B 5Q = 46,780 units of C Total = 112, 272 units Breakeven point increases because the new mix contains less of the higher contribution margin per unit, product B, and more of the lower contribution margin per unit, product C. 4. No, it is not always better to choose the sales mix with the l owest breakeven point because this calculation ignores the demand for the various products. The company should look to and sell as much of each of the three products as it can to maximize operating income even if this means that this sales mix results in a higher breakeven point. EA 3-26 3-34 CVP, not -for -profit. Recreational Music Society is a not -for -profit organization that brings guest artists to the community’s greater metropolitan area. The society just bought a small concert hall in the center of town to h ouse its performances. The lease payments on the concert hall are expected to be $6,000 per month. The organization pays its guest performers $2,200 per concert and anticipates corresponding ticket sales to be $6,000 per concert. The society also incurs co sts of approximately $1,400 per concert for marketing and advertising. The organization pays its artistic director $47,000 per year and expects to receive $23,000 in donations in addition to its ticket sales. Required : 1. If the Recreational Music Society j ust breaks even, how many concerts does it hold? 2. In addition to the organization’s artistic director, the society would like to hire a marketing director for $36,000 per year. What is the breakeven point? The society anticipates that the addition of a ma rketing director would allow the organization to increase the number of concerts to 50 per year. What is the society’s operating income/(loss) if it hires the new marketing director? 3. The society expects to receive a grant that would provide the organizati on with an additional $36,000 toward the payment of the marketing director’s salary. What is the breakeven point if the society hires the marketing director and receives the grant? SOLUTION CVP, Not for profit 1. Ticket sales per concert $ 6,000 Vari able costs per concert: Guest performers $ 2,200 Marketing and advertising 1,400 Total variable costs per concert 3,600 Contribution margin per concert $ 2,400 Fixed costs Salaries $47,000 Lease payments ($6,000 × 12) 72,00 0 Total fixed costs $119,000 Less donations 23,000 Net fixed costs $96,000 Breakeven point in units = = = 40 concerts Check Donations $ 23,000 Revenue ($6,000 × 40) 240,000 Net fixed costs Contribution margin per concert $96,000 $2,400 EA 3-27 Total reve nue 263,000 Less variable costs Guest performers ($2,200 × 40) $88,000 Marketing and advertising ($1,400 × 40) 56,000 Total variable costs 144,000 Less fixed costs Salaries $47,000 Lease payments 72,000 Total fixed costs 119,000 Operating income $ 0 2. Ticket sales per concert $ 6,000 Variable costs per concert: Guest performers $2,200 Marketing and advertising 1,400 Total variable costs per concert 3,600 Contribution margin per conce rt $ 2,400 Fixed costs Salaries ($47,000 + $36,000) $83,000 Lease payments ($6,000 × 12) 72,000 Total fixed costs $155,000 Less donations 23,000 Net fixed costs $ 132,000 Breakeven point in units = = = 55 concerts Check Donations $ 23,000 Revenue ($6,000 × 55) 303,000 Total revenue 353,000 Less variable costs Guest performers ($2,200 × 55) $121,000 Marketing and advertising ($1,400 × 55) 77,000 Tot al variable costs 198,000 Less fixed costs Salaries $83,000 Lease payments 72,000 Total fixed costs 155,000 Operating income $ 0 Net fixed costs Contribution margin per concert $132,000 $2,400 EA 3-28 Operating Income if 50 concerts are held Donations $ 23,000 Revenue ($6,000 × 50) 300,000 Total revenue 323,000 Less variable costs Guest performers ($2,200 × 50) $110,000 Marketing and advertising ($1,400 × 50) 70,000 Total variable costs 180,000 Less fixed costs Salaries $83,000 Lease payments 72,000 Tota l fixed costs 155,000 Operating income (loss) $(12,000 ) The society would not be able to afford the new marketing director if the number of concerts were to increase to only 50 events. The addition of the new marketing director would require the so ciety to hold at least 55 concerts in order to breakeven. If only 50 concerts were held, the organization would lose $12,000 annually. The society could look for other contributions to support the new marketing director’s salary or perhaps increase the n umber of attendees per concert if the number of concerts could not be increased beyond 50. 3. Ticket sales per concert $ 6,000 Variable costs per concert: Guest performers $ 2,200 Marketing and advertising 1,400 Total variable costs per concert 3,600 Contribution margin per concert $ 2,400 Fixed costs Salaries ($47,000 + $36,000) $83,000 Lease payments ($6,000 × 12) 72,000 Total fixed costs $155,000 Deduct donations 59,000 Net fixed costs $ 96,00 0 Breakeven point in units = = = 40 concerts Check Donations $ 59,000 Revenue ($6,000 × 40) 240,000 Total revenue 299,000 Net fixed costs Contribution margin per concert $96,000 $2,400 EA 3-29 Less variable costs Guest performers ($2,200 × 40) $88,000 Marketing and advertising ($1,400 × 40) 56,000 Total variable costs 144,000 Less fixed costs Salaries $83,000 Lease payments 72,000 Total fixed costs 155,000 Operating income $ 0 3-35 Contribution margin, decision ma king. Brandon Harris has a small bakery business called Super Bakery. Revenues and cost data of Super Bakery for the year 2016 are as follows: Sales revenues $475,000 Cost of goods sold (40% of sales revenues) 190,000 Gross margin 285,000 Operating costs: Salaries fixed $175,000 Sales commissions (15% of sales) 71,250 Depreciation of equipment and fixtures 22,000 Insurance for the year 5,000 Store rent ($5,000 per month) 60,000 Other operating costs 50,000 383,250 Operating income (loss) $(98,250) An analysis of other operating costs reveals that 80% of it varies with sales vo lume, and remaining 20% does not vary with sales volume rather remains same irrespective of sales volume. Required : 1. Compute the contribution margin of Super Bakery. 2. Compute the contribution margin percentage. 3. Mr. Harris estimates that if he can spend an additional $15,000 towards sales promotion, sales revenues may increase by 30%. What should Mr. Harris’ decision be? 4. What other actions can he take to improve the operating income? SOLUTION (15 min.) Contribution margin, decision making. 1. Revenues $475,000 Deduct variable costs: Cost of goods sold (40%) $190,000 Sales commissions 71,250 Other operating costs 40,000 301,250 Contribution margin $173,750 EA 3-30 2. Contribution margin percentage = = 36.58% (rounded) 3. Incremental revenue (30% × $475,000) = $142,500 Incremental contribution margin (36.58% × $142,500) $52,125 Incremental costs (sales promotion) 15,000 Incremental operating income $37,125 If Mr. Harris spends $15,000 more on sale s promotion, the operating income will increase by $37,125, decreasing the operating loss from $98,250 to an operating loss of $61,125.

Therefore, Mr. Harris should spend $15,000 more on sales promotion. Proof (Optional): Revenues (130% × $475,000) $617,50 0 Cost of goods sold (40% of sales revenue) 247,000 Gross margin 370,500 Operating costs: Salaries and wages $175,000 Sales commissions (15% of sales) 92,625 Depreciation of equipment and fixtures 22,000 Insurance for the year 5,000 Store rent 60,000 Sales promotion 15,000 Other operating costs: Variable 52,000 Fixed 10,000 431,625 Operating income $ (61,125 ) To improve operating income, Mr. Harris must find ways to decrease variable costs without compromising the quality of products, decrease fixed costs that can be avoided, or increase selling prices keeping in mind the selling prices of his competitors’ products. 3-36 Contribution margin, gross margin, and margi n of safety. Roma Skincare manufactures and sells a face cream to small specialty stores in Victoria, Australia. It presents the monthly operating income statement shown here to Jacob Scott, a potential investor in the business. Help Mr. Scott understand R oma Skincare’s cost structure. $173,750 $475,000 $40,000 $617, 500 $475,000    EA 3-31 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 Jun e 2017? 4. If sales in June were only 12,000 units and Roma Skincare’s tax rate is 30%, calculate its net income. SOLUTION (20 min.) Contribution margin, gross margin and margin of safety. 1. Roma Skincare Operating Income Statement, June 2017 Units s old 15,000 Revenues $1,20,000 Variable costs Variable manufacturing costs $60,000 Variable marketing costs 6,000 Total variable costs 66,000 Contribution margin 54,000 Fixed costs Fixed manufacturing costs $22,000 Fixed mark eting & administration costs 14,000 Total fixed costs 36,000 Operating income $18,000 2. EA 3-32 Contribution margin per unit Breakeven revenues = 10,000 units $8 per unit = $8 0,000 Alternatively, 3. Margin of safety (in units) = Units sold – Breakeven quantity = 15,000 units – 10,000 units = 5,000 units 4. Units sold 12,000 Revenues (Units sold Sell ing price = 12,000 $8) $96,000 Contribution margin (Revenues CM percentage = $96,000 45%) $43,200 Fixed costs 36,000 Operating income 7,200 Taxes (30% $7,200) 2,160 Net income $5,040 3-37 Uncertainty and expected costs. Futuremart is an international retail store. They are considering implementing a new business -to-business (B2B) information system for processing merchandise orders. The current system costs Futuremart $2,500,000 per month and $62 per order. Futuremart has two options, a partially automated B2B and a fully automated B2B system.

The partially automated B2B system will have a fixed cost of $7,200,000 per month a nd a variable cost of $50 per order. The fully automated B2B system has a fixed cost of $11,400,000 per month and $30 per order. Based on data from the past two years, Futuremart has determined the following distribution on monthly orders: Monthly Number o f Orders Probability 400,000 0.35 600,000 0.40 800,000 0.25 Required :       EA 3-33 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 systems costs, what other f actors should Futuremart 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 400,000 $2,500,000 + $62(400,000) = $27,300,000 600,000 $2,50 0,000 + $62(600,000) = $39,700,000 800,000 $2,500,000 + $62(800,000) = $52,100,000 Monthly Number of Orders Cost of Partially Automated System 400,000 $7,200,000 + $50(400,000) = $27,200,000 600,000 $7,200,000 + $50(600,000) = $37,200,0 00 800,000 $7,200,000 + $50(800,000) = $47,200,000 Monthly Number of Orders Cost of Partially Automated System 400,000 $11,400,000 + $30(400,000) = $23,400,000 600,000 $11,400,000 + $30(600,000) = $29,400,000 800,000 $11,400,000 + $3 0(800,000) = $35,400,000 2. Current System Expected Cost: $27,300,000 × 0.35 = $9,555,000 39,700,000 × 0.40 = 15,880,000 52,100,000 × 0.25 = 13,025,000 $38,460,000 Partially Automated System Expected Cost: $27,200,000 × 0.35 = $9,520 ,000 37,200,000 × 0.40 = 14,880,000 47,200,000 × 0.25 = 11,800,000 $36,200,000 Fully Automated System Expected Cost: $23,400,000 × 0.35 = $8,190,000 29,400,000 × 0.40 = 11,760,000 EA 3-34 35,400,000 × 0.25 = 8,850,000 $28,800,000 3. Futur emart should consider the impact of the different systems on its relationship with suppliers. The interface with Futuremart ’s system may require that suppliers also update their systems. This could cause some suppliers to raise the cost of their merchandis e. It could force other suppliers to drop out of Futuremart ’s supply chain because the cost of the system change would be prohibitive. Futuremart may also want to consider other factors such as the reliability of different systems and the effect on employe e morale if employees have to be laid off as it automates its systems. 3-38 CVP analysis, service firm. Appolo Healthcare Solutions provides preventive health check -up packages for men and women over 40 years of age and charges $12,500 per package on an average. The average variable costs per package are as follows: Doctor’s fees = $1,000 = Pathological tests and clinical examinations = 3,50M = Medicines = 2,80M = Refreshments and health drinks = = 30M = Costs of miscellaneous services = = 80M = Total = $8,400 = = Annual fixed costs total $900,000. = = Required W= 1. Calculate the number of health check -up packages that must be sold to break even. 2. Calculate the revenue needed to earn a target operating income of $270,000. 3. If fixed costs increase by $19,000, what decrease in variable cost per person must be achieved to maintain the breakeven point calculated in requirement 1? 4. The managing director at Appolo proposes to increase the average price of the packages by $900 to decrease the breakeven point in units. Using informa tion in the original problem, calculate the new breakeven point in units. What factors should the managing director consider before deciding to increase the price of the package? SOLUTION (15 –20 min.) CVP analysis, service firm . 1. Average revenue per package $12,500 Variable cost per package 8,400 Contribution margin per package $3,600 Breakeven (packages) = Fixed costs ÷ Contribution margin per package = = 250 health check -up packages 2. Contribution margin ratio = = = 30% $450,000 $3,600 per person p rice Selling p ackage p er margin on Contributi $3, 600 $12,000 EA 3-35 Revenue to achieve target income = (Fixed costs + target OI) ÷ Contribution margin ratio = = $11,700,000, or Number of health check -up packages to earn $270,000 operating income Revenues to earn $270,000 OI = 325 health check -up packages × $12,000 = $11,700,000. 3. Fixed costs = $900,000 + $25,000 = $925,000 Breakeven (packages) = Contribution margin per package = Desired variable cost per health check -up package = $12,000 – $3,700 = $8,300 Because the current variable cost per unit is $8,400, the unit variable cost will need to be reduced by $100 ($8,400 – $8,300) to achieve the breakeven point calculated in requirement 1. Alternate Method: If fixed cost increases by $25,000, then total variable costs must be reduced by $25,000 to keep the breakeven point of 250 health check -up packages. The refore, the variable cost per unit reduction = $25,000 ÷ 250= $100 per health check -up package. 4. Contribution margin per pac kage = $12,900 − $8,400 = $4,500 Breakeven (packages) = Fixed costs ÷ Contribution margin per package = $900,000 ÷ $4,500 per package = 200 health check -up packages Breakeven point in dollars = $12,900 per package × 200 health check -up packages = $2, 580,000 The key question for the managing director is: can Appolo Health -care Solutions sell enough health check -up packages at $12,900 per package to earn more total operating income than when selling packages at $12,000. Lowering the breakeven point per package should not be the objective. Appolo’s objective should be to increase the total operating income. 3-39 CVP, target operating income, service firm. Modern Beauty Parlor provides beauty treatment for women . Its average monthly variable costs per wo man are as follows: Materials for beauty treatment $1 10 Beautician’s commission 50 Other supplies ( soaps , napkins , etc.) 40 $900,000 $270,000 0.30  $900,000 $270,000 325 health check-up packages $3, 600   Fixed costs Contribution margin per package Fixed costs Breakeven (packages) $925,000 250 health check-up packages $3, 700 per health check-up package  EA 3-36 Total $200 Monthly fixed costs consist of the following: Rent $1,250 Utilities 300 Advertisements in a local TV channel 250 Salaries 1,500 Miscellaneous 300 Total $3,6 00 Modern Beauty charges $ 250 per woman on an average . Required : 1. Calculate the breakeven point. 2. Modern Beauty ’s target operating income is $4,000 per month. Compute the number of customers required to achieve the target operating income. 3. The parlo r wants to move to another building for geographical advantage. Monthly rent for the new building is $2,350. With the objective of better visibility for the prospective customers, it plans to advertise on another local TV channel, incurring a monthly cost of $420. By how much should the parlor increase its average fees per customer to meet the target operating income of $4,000 per month, assuming the same number of customers as in requirement 2? SOLUTION (30 min.) CVP, target operating income, service firm. 1. Revenue per woman $250 Variable costs per woman 200 Contribution margin per woman $ 50 Breakeven poi nt = = = 72 woman per month 2. Target number of woman = = = 152 woman per month 3. Increase in rent ($2,350 – $1,250) $1,100 New advertisement 420 Total increase in fixed costs $1,520 Fixed costs per momth Contribution margin per woman $3,600 $50 Fixed costs Target operating income Contribution margin per woman  $3,600 $4,000 $50  EA 3-37 Divide by the number of woman ÷ 152 Increase in average charge per woman $ 10 Therefore, the charge per woman will increase from $250 to $260. Alternatively, New contri bution margin per woman = = $60 New average charge per woman = Variable costs per woman + New contribution margin per woman = $200 + $60 = $260 3-40 CVP analysis, margin of safety. United Project Cons ultants (UPC) provides project consultancy services to new business projects. For 2017, it has a total budgeted -revenue of $480,000, based on an average price of $240 per business project prepared. UPC would like to achieve at least 50% as a margin of safe ty. The company’s current fixed costs are $241,956, and variable costs average $42 per project. (Consider each of the following separately.) Required : 1. Calculate UPC's breakeven point and margin of safety in units. 2. Which of the following changes would help UPC achieve its desired margin of safety? a. Average revenue per business project increases to $276. b. Planned number of business projects prepared increases by 25% c. United Project Consultants purchases new tax -software that results in a 7.5% increase i n fixed costs, but makes project calculations easier. The software reduces variable costs by an average of $2 per project. SOLUTION CVP analysis, margin of safety. 1. Selling price $240 Variable costs per unit: 42 Contribution margin pe r unit (CMU) $198 Breakeven point in units = Breakeven point in units = business projects (units) Margin of safety (units) = 2,000* – 1,222 = 778 business projects (units) *$480,000 budge ted revenue÷$240 = 2,000 business projects (units) $3,600 $1, 520 $4, 000 152  Fixed costs Contribution margin per unit $241,956 1, 222 $198  EA 3-38 Breakeven revenues = $240× 1,222 = $293,280 Margin of safety percentage = ($480,000−$293,280) ÷ $480,000= 38.90% 2a. Increase selling price to $276 Selling price $276 Variable costs per unit: 42 Contribution margin per unit (CMU) $234 Breakeven point in units = Breakeven point in units = = 1,034 business projects (units) Breakeven revenues = $276 × 1,034 units = $285,384 Margin of safety percentage = ($480,000 − $285,384) ÷ $480,000 = 40.55% (rounde d) This change will not help United Project Consultants achieve its desired margin of safety of 40%. 2b. Selling price $240 Variable costs per unit: 42 Contribution margin per unit (CMU) $198 Breakeven point in units = Breakeven point in units = business projects (units) Breakeven revenues = $240× 1,222 = $293,280 Budgeted revenues = $480,000 × 1.25 = $600,000 Margin of safety percentage = ($600,000 − $293,280) ÷ $600,000 = 51.12% This change will help Arvin achieve its desired margin of safety of 50%. 2c. Selling price $240 Variable costs per unit ($42 – $2): 40 Contribution margin per unit (CMU) $200 Fixed costs = $241,956 × 1.075 = $260,103 (rounded) Fixed costs Contribution margin per unit $241,956 $234 Fixed costs Contribution margin per unit $241,956 1, 222 $198  EA 3-39 Breakeven point in units = Breakeven point in units = = 1,301 business projects/units (rounded up) Bre akeven revenues = $240 × 1,301 units = $312,240 Mar gin of safety percentage = ($480,000− $312,240) ÷ $480,000= 34.95% This change will not help United Project Consultants achieve its desired margin of safety of 50%. Options 2a and 2b both improve the margin of safety, but only option 2b exceeds the compan y’s desired margin of safety. Option 2c actually lowers the company’s margin of safety. Therefore, option only 2b would help United Project Consultants achieve its desired margin of safety. 3-41 CVP analysis, income taxes. (CMA, adapted) J.T. Brooks an d 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 yea r to maintain the company’s present growth. To pr epare 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 f or 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 remaini ng 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 advert ising? Fixed costs Contribution margin per unit $260,1$ 03 $200 EA 3-40 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 ? SOLUTION (30 –40 min.) CVP analysis, income taxes. 1. Revenues – Variable costs – Fixed costs = Let X = Net income for 2017 22,000($35.00) – 22,000($18.50 ) – $214 ,500 = $77 0,000 – $407 ,000 – $214,5 00 = $462 ,000 – $244 ,200 – $128 ,700 = X X = $ 89 ,100 Alternatively, Operating income = Revenues – Variable costs – Fixed costs = $ 770 ,000 – $407 ,000 – $214 ,500 = $ 148 ,500 Income taxes = 0.40 × $ 148 ,500 = $59 ,400 Net income = Operating income – Income taxes = $ 148 ,500 – $59 ,400 = $ 89 ,100 2. Let Q = Number of units to break even $3 5.00Q – $18.50 Q – $214 ,500 = 0 Q = $ 214 ,500  $16.50 = 13 ,000 units 3. Let X = Net income for 2018 25,000($35.00) – 25,000($18.50 ) – ($214 ,500 + $ 16,500 ) = $875 ,000 – $46 2,500 – $231,000 = $1 81,50 0 = X = $ 108,900 4. Let Q = Number of units to break even with new fixed costs of $146,250 $3 5.00Q – $18.50 Q – $231,000 = 0 Q = $ 231,000  $16.50 = 14 ,000 units Breakeven revenues = 14 ,000  $35.00 = $490 ,000 5. Let S = Required sales units to equa l 2 017 net income $3 5.00S – $1 8.50 S – $231,000 = $16.50 S = $379,500 rate Tax 1 income net Target  X 1 0.40 X 0.60 X 1 0.40 X 0.60 X 0.60 $89,100 0.60 EA 3-41 S = 23,000 units Revenues = 23,000 units  $3 5 = $ 80 5,000 6. Let A = Amou nt spent for advertising in 2018 $875 ,000 – $462 ,500 – ($214 ,500 + A) = $875 ,000 – $46 2,500 – $214,500 – A = $180,750 $875 ,000 – $857,750 = A A = $17,250 3-42 CVP, sensitivity analysis. Mundial Nails produces a famous nail polish with a unique glossy feature and sells it for $25 per unit. The operating income for 2017 is as follows: Per unit ($) Total ($) Sales revenue $25 $750,000 Raw -materials 5 150,000 Variable manufacturing costs 4 120,000 Other variable costs 6 180,000 Contribution margin 10 300,000 Fixed cost 174,000 Operating income $126,000 Mundial Nails would like to increase its profitability over the next year by at least 20%. To do so, the company is considering the following options: Required : 1. Replacing a portion of its variable labor with an automated machining process. This would r esult in a 25% decrease in variable manufacturing costs per unit, but a 20% increase in fixed costs. Sales would remain the same. 2. Spending $30,000 on a new advertising campaign, which would increase sales by 20%. 3. Increasing both selling price by $5 per uni t and raw -material costs by $3 per unit by using a higher -quality raw materials in producing its nail polish. The higher -priced nail polish would cause demand to drop by approximately 20%. 4. Adding a second manufacturing facility that would double Mundial Na ils’ fixed costs, but would increase sales by 60%. Evaluate each of the alternatives considered by Mundial Nails. Do any of the options meet or exceed Mundial’s targeted increase in income of 25%? What should Mundial Nails do? SOLUTION (25 min.) CVP, sen sitivity analysis . $108,450 0.60 EA 3-42 Contribution margin per unit = $25 – $15 = $10 Fixed costs = $174,000 Units sold = Total sales ÷ Selling price = $750,000 ÷ $25 per pair = 30,000 units Variable costs per unit = $5 +$4 + $6 = $15 1. variable manufacturing costs per unit de crease by 25%; Fixed costs increase by 20% Sales revenues: 30,000 $25 $750,000 Variable costs: 30,000 ($15 – $4 0.25) 420,000 Contribution margin: 30,000 $11 330,000 Fixed costs $174,000 1.20 208,800 Operating income $121,200 2. Increase advertising (fixed costs) by $30,000; Increase sales 20% Sales revenues: 30,000 1.20 $25.00 $900,000 Variable costs: 30,000 1.20 $15.00 540,000 Contribution margin 360,000 Fixed costs: ($174,000 + $30,000) 204,000 Operating income $ 156,000 3. Increase selling price by $ 5; Sales decrease 20%; Increase Raw -material costs by $3 Sales revenues: 30,000 (1 –0.2) ($25 + $5) $720,000 Variable costs: 30,000 (1 –0.2) ($15 + $3) 432,000 Contribution margin: 30,000 (1 –0.2) $12 288,000 Fixed costs 174,000 Operating income $ 114,000 4. Double fixed costs; Increase sales by 60% Sales revenues: 30,000 1.60 $25 $1,200,000 Variable costs: 30,000 1.60 $15 720,000 Contribution margin: 30,000 1.60 $10 480,000 Fixed costs $100,000 2 348,000 Operating income $132,000 Alternative 2 yields the highest operating income. Choosing alternative 2 will give Mundial Nails a 23.81% [($156,000 – $126,000)/$126,000 = 23.81%] increase in operating inc ome, which is less than the company’s 25% targeted increase. Alternative 4 also generates more operating income for Mundial Nails, but it too does not meet Mundial Nails’ target of 25% increase in operating income. Alternatives 1 and 3 actually result in l ower operating income than under Mundial Nails’ current cost structure. There is no reason, however, for Mundial Nails to think of these alternatives as being mutually exclusive. For example, Mundial Nails can combine actions 1 and 2, automate the machini ng process and spend for a new advertising campaign and by this process increase sales by 20% and decrease variable manufacturing costs per unit by 25% while increasing fixed costs by 20% and spending $30,000 for the new advertisement campaign. This will r esult in a 24.76% [($157,200 – $126,000)/$126,000 = 24.76%] increase in operating income as follows:                       EA 3-43 Sales revenue: 30,000 1.20 $25 $900,000 Variable costs: 30,000 1.20 ($15 – $4× 0.25) 504,000 Contribution margin: 30,000 1.20 $11 396,000 Fixed costs: $174,000 1.20 + $30,000 238,800 Operating income $157,200 The po int of this problem is that managers always need to consider broader rather than narrower alternatives to meet ambitious future or stretch goals. 3-43 CVP analysis, shoe stores. The LadyStyle sells women’s shoes across the country through its chain of shoe stores. It sells 20 different styles of shoes with identical unit costs and selling prices. A unit is defined as a pair of shoes. Each store has a store manager and a store supervisor who are paid a fixed salary. Shoes are sold by sales -women who receive a fixed salary and a sales commission. LadyStyle is considering opening another store that is expected to have the revenue and cost relationships shown here. Consider each question independently. Required: 1. What is the annual breakeven point in (a) unit s sold and (b) revenues? 2. If 15,000 units are sold, what will be the store’s operating income (loss)? 3. If sales commissions are discontinued and fixed salaries are raised by a total of $19,190, what would be the annual breakeven point in (a) units sold and (b) revenues? 4. Refer to the original data. If, in addition to their fixed salary, the store supervisor and store manager are paid a commission of $0.50 per unit sold and $1.00 per unit sold respectively, what would be the annual breakeven point in (a) unit s sold and (b) revenues? 5. Refer to the original data. If, in addition to their fixed salary, the store supervisor and store manager are paid a commission of $0.50 per unit and $1.00 per unit sold respectively in excess of the breakeven point, what would be the store’s operating income if 25,000 units were sold? SOLUTION (20–30 min.) CVP analysis, shoe stores. 1. CMU (SP – VCU = $40 – $31) $ 9.00 a. Breakeven units (FC CMU = $171,000 $9 per unit) 19,000 b. Breakeven revenues          EA 3-44 (Breakeven units SP = 19,000 units $40 per unit) $760,000 2. Pairs sold 15,000 Revenues, 15,000 $40 $600,0 00 Total cost of shoes, 15,000 $29 435,000 Total sales commissions, 15,000 $2 30,000 Total variable costs 465,000 Contribution margin 135,000 Fixed costs 171,000 Operating income (loss) $ (36,000 ) 3. Unit variable data (per pair of shoes) Selling price $ 40.00 Cost of shoes 29.00 Sales commissions 0 Variable cost per unit $ 29.00 Annual fixed c osts Rent $ 25,000 Salaries, $96,000 + $19,190 115,190 Advertising 35,000 Depreciation 6,000 Other fixed costs 9,000 Total fixed costs $ 190,190 CMU, $40 – $29 $ 11 a. Breakeven un its, $190,190 $11 per unit 17,290 b. Breakeven revenues, 17,290 units $40 per unit $691,600 4. Unit variable data (per pair of shoes) Selling price $ 40.00 Cost of shoes 29.00 Sales commissions 3.50 Variable cost per unit $ 32.50 Total fixed costs $171,000 CMU, $40 – $32.5 $ 7.50 a. Break even units = $171,000 $7.50 per unit 22,800 b. Break even rev enues = 22,800 units $40 per unit $912,000 5. Pairs sold 25,000 Revenues (25,000 pairs $40 per pair) $1,000,000 Total cost of shoes (25,000 pairs $29 per pair) 725,000 Sales commissions on first 19,000 pairs (19,000 pairs $2 per pair) 38,000 Sales commissions on additional 6,000 pairs [6,000 pairs ($2 + $1.50 per pair)] 21, 000 Total variable costs 784,000 Contribution margin 216,000 Fixed costs 171,000              EA 3-45 Operating income $ 45,000 Alternative approach: Breakeven point in units = 19,000 pairs Store manager and store supervisor receive commission of $1.50 ($1+$0.50) on 6,000 (25,000 – 19,000) pairs. Contribution margin per pair beyond breakeven point of 19,000 pairs = $7.50 ($40 – $31 – $1.50) per pair. Operating income = 6,000 pairs $7.50 contribution margin per pair = $45,000. 3-44 CVP analysis, shoe stores (continuation of 3 -43). Refer to requirement 3 of Problem 3 - 43. In this problem, assume the role of the owner of LadyStyle. Required: 1. As owner, which sales compensation plan would you choose if forecasted annual sales of the new store were at least 25,000 units? What do you think of the motivational aspect of your chosen compensation plan? 2. Suppose the target operating income is $99,000. How many units must be sold to reach the target operating income under (a) the original salary -plus -commissions plan and (b) the higher -fixed -salaries -only plan? Which method would you prefer? Explain briefly. 3. You open the new store on January 1, 2017, with the original salary -plus -commission compensation plan in place. Becau se you expect the cost of the shoes to rise due to inflation, you place a firm bulk order for 25,000 shoes and lock in the $29 price per unit. But toward the end of the year, only 20,000 shoes are sold, and you authorize a markdown of the remaining invento ry to $35 per unit. Finally, all units are sold. Salespeople, as usual, get paid a commission of 5% of revenues. What is the annual operating income for the store? SOLUTION (30 min.) CVP analysis, s hoe stores (continuation of 3 -43 ). 1. For an expected vol ume of 25,000 pairs, the owner would be inclined to choose the higher - fixed -salaries -only plan because income would be much higher by $ 30 ,810 compared to the salary -plus -commission plan. Operating income for salary plan = $11 × 25,000 – $190,190 = $84,8 10 Operating income under commission pan = $ 9 × 25,000 – $171,000 = $ 54,0 00 However, it is likely that sales volume itself is determined by the nature of the compensation plan. The salary -plus -commission plan provides a greater motivation to the salespeop le, and it may well be that for the same amount of money paid to salespeople, the salary -plus -commission plan generates a higher volume of sales than the fixed -salary plan. 2. Let TQ = Target number of units For the salary -only plan, $40TQ – $29TQ – $190,190 = $99,000  EA 3-46 $11TQ = $289,190 TQ = $289,190 ÷ $11 TQ = 26,290 units For the salary -plus -commission plan, $40TQ – $31 TQ – $171,000 = $99,000 $9TQ = $270,000 TQ = $270,000 ÷ $ 9 TQ = 3 0,000 units The decision regarding the salary -plus -comm ission plan depends heavily on predictions of demand. For instance, the salary -only plan offers the same operating income at 26,290 units as the commission plan offers at 3 0,000 units. 3. LadyStyle Operatin g Income Statement, 2017 Revenues (20,000 pairs $40) + (5,000 pairs $35) $975,000 Cost of shoes, 25,000 pairs $29 725,000 Commissions = Revenues 5% = $975,000 0.05 48,750 Contribution margin 201,250 Fixed costs 171,000 Operating income $ 30,250 3-45 Alternate cost structures, uncertainty, and sensitivity analysis. Sunshine Printing Company currently leases its only copy machine for $1,500 a month. The company is considering replacing this leasing agreement with a new contract that is entirely commission based. Under the new agreement, Sunshine would pay a commission for its printing at a ra te of $10 for every 500 pages printed. The company currently charges $0.20 per page to its customers. The paper used in printing costs the company $0.08 per page and other variable costs, including hourly labor, amount to $0.07 per page. Required: 1. What is the company’s breakeven point under the current leasing agreement? What is it under the new commission -based agreement? 2. For what range of sales levels will Sunshine prefer (a) the fixed lease agreement and (b) the commission agreement? 3. Do this questio n only if you have covered the chapter appendix in your class. Sunshine estimates that the company is equally likely to sell 30,000, 45,000, 60,000, 75,000, or 90,000 pages of print. Using information from the original problem, prepare a table that shows t he expected profit at each sales level under the fixed leasing agreement and under the commission -based agreement. What is the expected value of each agreement? Which agreement should Sunshine choose? SOLUTION (40 min.) Alternative cost structures, unce rtainty, and sensitivity analysis.      EA 3-47 1. Contribution margin per page assuming current fixed leasing agreement = $0.20 –=$0.08 –=$0.07 = $0.05 per page = Fixed costs = $1,500 = Breakeven point = = = New commission Jbased agreement = Contr ibution margin per page = assuming $10 per 500 page = commission agreement = = $0.20 –=$0.0O a –=$0.08 –=$0.07 = $0.03 per page = = Fixed costs = $0 = Breakeven point = = (i.e., Sunshine makes a profit no matter how few pages it sells) = a$10 500 pages = $0.02 per page 2. Let denote the number of pages Sunshine must sell for it to be indifferent between the fixed leasing agreement and commission based agreement. To calculate we solve the fol lowing equation. $0.20 – $0.08 – $0.07 – $1,500 = $0.20 – $0.02 – $0.08 – $.07 $0.05 – $1,500 = $0.03 $0.02 = $1,500 = $1,500 ÷ $0.02 = 75,000 pages For sales between 0 to 75,000 pages, Sunshine prefers the commission -based a greement because in this range, $0.03 > $0.05 – $1,500. For sales greater than 75,000 pages, Sunshine prefers the fixed leasing agreement because in this range, $0.05 – $1,500 > $0.03 . 3. Fixed leasing agreement Pages Sold (1) Revenue (2) Variable Costs (3) Fixed Costs (4) Operati ng Income (Loss) (5) = (2) – (3) – (4) Prob abi lity (6) Expected Operating Income (7)=(5) (6 ) 30,000 30,000 $.20 = $ 6,000 30,000 $.15 = $4,500 $1,500 $ 0 0.20 $ 0 45,000 45,000 $.20 = $ 9,000 45,000 $.15=$6,750 $1,500 $ 750 0.20 150 60,000 60,000 $.20 = $ 12,000 60,000 $.15=$9,000 $1,500 $1,500 0.20 300 75,000 75,000 $.20 = $ 15,000 75,000 $.15=$11,25 0 $1,500 $2, 250 0.20 450 90,000 90,000 $.20 = $ 18,000 90,000 $.15=$13,50 0 $1,500 $3,000 0.20 600 Fixed costs $1, 500 30, 000 pages Contribution margin per page $0.05 per pa ge  Fixed costs $0 0 pages Contribution margin per page $0.03 per pa ge   x x x x x x x x x x x x x x x x x            EA 3-48 Expected value of fixed leasing agreement $1,500 Commission -based leasing agreement : Pages Sold (1) Revenue (2) Variable Costs (3) Operating Income (4) = (2) – (3) Probabil ity (5) Expected Operati ng Income (6)=(4) (5) 30,000 30,000 $.20 = $ 6,000 30,000 $.17 = $5100 $900 0.20 $ 180 45,000 45,000 $.20=$ 9,000 45,000 $.17=$,7,650 $1,350 0.20 270 60,000 60,000 $.20 = $ 12,000 60,000 $.17 = $10,200 $1,800 0.2 0 360 75,000 75,000 $.20=$ 15,000 75,000 $.17=$12,750 $2,250 0.20 450 90,000 90,000 $.20=$ 18,000 90,000 $.17=$15,300 $2,700.00 0.20 540 Expected value of commission based agreement $1,800 Sunshine should choose the commission -based agreement becau se the expected value is higher than under the fixed cost leasing agreement. The range of sales is not high enough (i.e. >75,000) to make the fixed leasing agreement more attractive. 3-46 CVP, alternative cost structures. TopHats operates a kiosk at a l ocal mall, selling hats for $30 each. TopHats currently pays $900 a month to rent the space and pays three full -time employees to each work 160 hours a month at $12 per hour. The store shares a manager with a neighboring mall and pays 40% of the manager’s annual salary of $60,000 and benefits equal to 18% of salary. The wholesale cost of the hats to the company is $10 a hat. Required : 1. How many hats does TopHats need to sell each month to break even? 2. If TopHats wants to earn an operating income of $5,000 per month, how many hats does the store need to sell? 3. If the store’s hourly employees agreed to a 20% sales -commission -only pay structure, instead of their hourly pay, how many hats would TopHats need to sell to earn an operating income of $5,000? 4. Assume TopHats pays its employees hourly under the original pay structure, but is able to pay the mall 5% of its monthly revenue instead of monthly rent. At what sales levels would TopHats prefer to pay a fixed amount of monthly rent, and at what sales levels wo uld it prefer to pay 5% of its monthly revenue as rent? SOLUTION (20 -30 min.) CVP, alternative cost structures. 1. Variable cost per unit = $10 Contribution margin per unit = Selling price –Variable cost per unit = $30 – $10 = $20 Fixed Co sts: Manager’s salary ($60,000 × 1.18 × 0.4) ÷12 $2,360 per month            EA 3-49 Rent 900 per month Hourly employee wages (3 × 160 hours × $12) 5,760 per month Total fixed costs $9,020 per month Breakeven point = Fixed costs ÷ Contributio n margin per unit = $9,020 ÷ $20 = 451 hats (per month) 2. Target number of hats = = 3. Contribution margin per unit = Selling price – Variable cost per computer = $30 – (0.20 × $30) – $10 = $14 Fixed costs = Manager’s salary + Rent = $2,360 + $900 = $3,260 Target number of hats = = 4. Let be the number of hats for which TopHats is indifferent between paying a monthly rental fee for the retail space and paying a 5% commission on sales. TopHats will be indifferent when the operating incomes under the two alternatives are equal. $30 − $10 – $9,020 = $30 – $10 − $30 (0.05) − $8,120 $20 – $9,020 = $18.50 − $8,120 $1.50 = $900 = 600 hats For sales between 0 and 600 hats, TopHats prefers to pay the 5% commission because in this range, $18.50 − $8,120 > $20 – $9,020. For sa les greater than 600 hats, the company prefers to pay the monthly fixed rent of $900 because $20 – $9,020> $18.50 − $8,120. 3-47 CVP analysis, income taxes, sensitivity. (CMA, adapted) Carlisle Engine Comp any manufactures and sells diesel engines for use in small farming equipment. For its 2014 budget, Carlisle Engine Company estimates the following: Selling price $ 4,000 Variable cost per engine $ 1,000 Annual fixed costs $4,800,000 Net income $1,200,000 Income tax rate 20% The first -quarter income statement, as of March 31, reported that sales were not meeting Fixed costs + Target operating income Contribution margin per unit $9,020 + $5,000 701 hats $20  Fixed costs + Target operating income Contribution margin per unit $ + $5,000 590 hats $14 3, 260  x x x x x x x x x x x x x x EA 3-50 expectations. During the first quarter, only 400 units had been sold at the current price of $4,000.

The income stat ement showed that variable and fixed costs were as planned, which meant that the 2014 annual net income projection would not be met unless management took action. A management committee was formed and presented the following mutually exclusive alternatives to the president: Required : 1. Reduce the selling price by 15%. The sales organization forecasts that at this significantly reduced price, 2,100 units can be sold during the remainder of the year. Total fixed costs and variable cost per unit will stay as bu dgeted. 2. Lower variable cost per unit by $300 through the use of less -expensive direct materials. The selling price will also be reduced by $400, and sales of 1,750 units are expected for the remainder of the year. 3. Reduce fixed costs by 10% and lower the selling price by 30%. Variable cost per unit will be unchanged. Sales of 2,200 units are expected for the remainder of the year. a. If no changes are made to the selling price or cost structure, determine the number of units that Carlisle Engine Company must sell (i) to break even and (ii) to achieve its net income objective. b. Determine which alternative Carlisle Engine should select to achieve its net income objective. Show your calculations. SOLUTION (30 min.) CVP analysis, income taxes, sensitivity. 1a.T o breakeven, Carlisle Engine Company must sell 1,200 units. This amount represents the point where revenues equal total costs. Let Q denote the quantity of engines sold. Revenue = Variable costs + Fixed costs $4,000Q = $1000Q + $4,800,000 $3,000Q = $4,8 00,000 Q = 1,600 units Breakeven can also be calculated using contribution margin per unit. Contribution margin per unit = Selling price – Variable cost per unit = $4,000 – $1,000 = $3,000 Breakeven = Fixed Costs  Contribution margin per un it = $4,800,000  $3,000 = 1,600 units 1b. To achieve its net income objective, Carlisle Engine Company must sell 2,100 units. This amount represents the point where revenues equal total costs plus the corresponding operating income objective to achieve net income of $1,200,000. Revenue = Variable costs + Fixed costs + [Net income ÷ (1 – Tax rate)] $4,000Q = $1,000Q + $4,800,000 + [$1,200,000  (1  0.20)] $4,000Q = $1,000Q + $4,800,000 + $1,500,000 Q = 2,100 u nits EA 3-51 2. None of the alternatives will help Carlisle Engineering achieve its net income objective of $1,200,000. Alternative b, where variable costs are reduced by $300 and selling price is reduced by $400 resulting in 1,750 additional units being sold through the end of the year, yields the highest net income of $1,180,000. Carlisle’s managers should examine how to modify Alternative b to further increase net income. For example, could variable costs be decreased by more than $300 per unit or selling p rices decreased by less than $400? Calculations for the three alternatives are shown below. Alternative a Revenues = ($4,000  400) + ($3,400 a  2,100) = $8,740,000 Variable costs = $1,000  2,500 b = $2,500,000 Operating income = $8,740,000  $2,500,000  $4,800,000 = $1,440,000 Net income = $1,440,000  (1  0.20) = $1,152,000 a$4,000 – ($4,000 × 0.15) ; b400 units + 2,100 units. Alternative b Revenues = ($4,000  400) + ($3,600 a  1,750) = $7,900,000 Variable costs = ($1,000  400) + (700 b  1,750) = $1,625,000 Operating income = $7,900,000  $1,625,000  $4,800,000 = $1,475,000 Net income = $1,475,000  (1  0.20) = $1,180,000 a$4,000 – 400 ; b$1,000 – $300. Alternative c Revenues = ($4,000  400) + ($2,800 a  2,200) = $7,760,000 Variable costs = $1,000  2,600 b = $2,600,000 Operating income = $7,760,000  $2,600,000  $4,320,000 c = 840,000 Net income = $840,000  (1  0.20) = $672,000 a$4,000 – ($4,000  0.30); b400 units + 2,200nits; c$4,800,000 – ($4,800,000  0.10) 3-48 Choosing between compensation plans, operating leverage. CMA, adapted) AgroPharm Corporation manufactures pharmaceutical products that are sold through a network of external sales agents. The agents are paid a commission of 18% of revenues.

AgroPharm is considering replaci ng the sales agents with its own salespeople, who would be paid a commission of 12% of revenues and total salaries of $7,950,000. The income statement for the year ending December 31, 2017, under the two scenarios is shown here. EA 3-52 Required: 1. Calculate AgroP harm’s 2017 contribution margin percentage, breakeven revenues, and degree of operating leverage under the two scenarios. 2. Describe the advantages and disadvantages of each type of sales alternative. 3. In 2018, AgroPharm uses its own salespeople, who demand a 14% commission. If all other cost -behavior patterns are unchanged, how much revenue must the salespeople generate in order to earn the same operating income as in 2017? SOLUTION (30 min.) Choosing between compensation plans, operating leverage. 1. We c an recast AgroPharm’s income statement to emphasize contribution margin, and then use it to compute the required CVP parameters. AgroPharm Corporation Income Statement for the Year Ended Decemeber 31, 2017 Using Sales Agents Using Own Sales Force Rev enues $45,000,000 $45,000,000 Variable Costs Cost of goods sold − variable = $15,750,00M = = $15,750,00M = = Marketing commissions = = 8,100,00 0 = 23,850,000 = 5,400,00 0 = 21,150,000 = Contribution margin = = $21,150,00M = = $23,850,00M = Fixed costs = = = = = Cost of goods sold − fixed = $5,425,000 = = $5,425,000 = = EA 3-53 Marketing fixed 5,250,00 0 10,675,000 7,950,00 0 13,375,000 Operating income $10,475,000 $10,475,000 Contribution margin percentage 47.00% 53.00% ($21,150,000 -:-$45,000,000; $23,850,000÷$45,000,000) Breakeven revenues $22,712,766 $25,235,849 ($10,675,000 ÷ 0.47; $13,375,000 ÷ 0.53) Degree of operating leverage 2.02 2.28 ($21,150,000 ÷ $10,475,000; $23,8 50,000 ÷ $10,475,000) 2. The calculations indicate that at sales of $45,000,000, a percentage change in sales and contribution margin will result in 2.02 times that percentage change in operating income if AgroPharm continues to use sales agents and 2.28 times that percentage change in operating income if AgroPharm employs its own sales staff. The higher contribution margin per dollar of sales and higher fixed costs gives AgroPharm more operating leverage, that is, greater benefits (increases in opera ting income) if revenues increase but greater risks (decreases in operating income) if revenues decrease. AgroPharm also needs to consider the skill levels and incentives under the two alternatives. Sales agents have more incentive compensation and, hence, may be more motivated to increase sales. On the other hand, AgroPharm’s own sales force may be more knowledgeable and skilled in selling the company’s products. That is, the sales volume itself will be affected by who sells and by the nature of the compen sation plan. 3. Variable costs of marketing = 14% of Revenues Fixed marketing costs = $7,950,000 Operating income = Revenues     Denote the revenues required to earn $10,475,000 of operating income by R, then R  0.35R  $5,425,000  0.14R  $7,950,000 = $10,475,000 R  0.35R  0.14R = $5,425,000 + $7,950,000 + $10,475,000 0.51R = $23,850,000 R = $$23,850,000  0.51 = $46,764,706 3-49 Sales mix, three products. The Matrix Company has three product lines of belts — A, B, and C — with contribution margins of $7, $5, and $4, respectively. The president foresees sales of costs manuf.

Variable costs manuf. Fixed cost s market ing Variable cost s market ing Fixed EA 3-54 400,000 units in the coming period, consisting of 40,000 units of A, 2 00,000 units of B, and 160,000 units of C. The company’s fixed costs for the period are $1,020,000. Required : 1. What is the company’s breakeven point in units, assuming that the given sales mix is maintained? 2. If the sales mix is maintained, what is the tota l contribution margin when 400,000 units are sold? What is the operating income? 3. What would operating income be if 40,000 units of A, 160,000 units of B, and 200,000 units of C were sold? What is the new breakeven point in units if these relationships pers ist in the next period? SOLUTION (15 –25 min.) Sales mix, three products. 1. Sales of A, B, and C are in ratio 40,000 : 200,000 : 160,000. So for every 1 unit of A, 5 (200,000 ÷ 40,000) units of B are sold, and 4 (160,000 ÷ 40,000) units of C are sold. Co ntribution margin of the bundle = 1  $7 + 5  $5 + 4  $4 = $7 + $25 + $16 = $48 Breakeven point in bundles = = 21,250 bundles Breakeven point in units is: Product A: 21,250 bundles × 1 unit per bundle 21,250 units Product B: 21,250 bundles × 5 units per bundle 106,250 units Product C: 21,250 bundles × 4 units per bundle 85,000 units Total number of units to breakeven 212,500 units Alternatively, Let Q = Number of units of A to break even 5Q = Number of uni ts of B to break even 4Q = Number of units of C to break even Contribution margin – Fixed costs = Zero operating income $7Q + $5(5Q) + $4(4Q) – $1,020,000 = 0 $48Q = $1,020,000 Q = 21,250 ($1,020,000 ÷ $48) units o f A 5Q = 106,250 units of B 4Q = 85,000 units of C Total = 212,500 units 2. Contribution margin: A: 40,000  $7 $ 280,000 B: 200,000  $5 1,000,000 $1, 020, 000 $48 EA 3-55 C: 160,000  $4 640 ,000 Contribution margin $1,920,000 Fixed costs 1,020,000 Operating income $ 900,000 3. Contribution margin A: 40,000  $7 $ 280,000 B: 160,000  $5 800,000 C: 200,000  $4 800,000 Contribution margin $1,880,000 Fixed costs 1,020,000 Operating income $ 860,000 Sales of A, B, and C are in ratio 40,000 : 160,000 : 200,000. So for every 1 unit of A, 4 (160,000 ÷ 40,000) units of B and 5 (200,000 ÷ 40,000) units of C are sold. Contribution margin of the bundle = 1  $7 + 4  $5 + 5  $4 = $7 + $20 + $20 = $47 Breakeven point in bundles = = 21,703 bundles (rounded up) Breakeven point in units is: Product A: 21,703 bund les × 1 unit per bundle 21,703 units Product B: 21,703 bundles × 4 units per bundle 86,812 units Product C: 21,703 bundles × 5 units per bundle 108,515 units Total number of units to breakeven 217,030 units Alternatively, Let Q = Number of u nits of A to break even 4Q = Number of units of B to break even 5Q = Number of units of C to break even Contribution margin – Fixed costs = Breakeven point $7Q + $5(4Q) + $4(5Q) – $1,020,000 = 0 $47Q = $1,020,000 Q = 21,703 ($1,020,000 ÷ $47) units of A (rounded up) 4Q = 86,812 units of B 5Q = 108,515 units of C Total = 217,030 units Breakeven point increases because the new mix contains less of the higher contribution margin per unit, product B, and more of the lower con tribution margin per unit, product C. 3-50 Multiproduct CVP and decision making. Romi Filters produces two types of water filters. One attaches to the faucet and cleans all water that passes through the faucet; the other is a pitcher -cum -filter that only purifies water meant for drinking. The unit that attaches to the faucet is sold for $150 and has variable costs of $90. $1, 020, 000 $47 EA 3-56 The pitcher -cum -filter sells for $160 and has variable costs of $80. Romi Filters sells two faucet models for every three pitchers s old. Fixed costs equal $1,260,000. Required : 1. What is the breakeven point in unit sales and dollars for each type of filter at the current sales mix? 2. Romi Filters is considering buying new production equipment. The new equipment will increase fixed cost by $240,000 per year and will decrease the variable cost of the faucet and the pitcher units by $5 and $10, respectively. Assuming the same sales mix, how many of each type of filter does Romi Filters need to sell to break even? 3. Assuming the same sales mix, at what total sales level would Romi Filters be indifferent between using the old equipment and buying the new production equipment? If total sales are expected to be 28,000 units, should Romi Filters buy the new production equipment? SOLUTION (40 min.) Multi -product CVP and decision making. 1. Faucet filter: Selling price $150 Variable cost per unit 90 Contribution margin per unit $60 Pitcher -cum -filter: Selling price $160 Variable cost per unit 80 Contribution margin per unit $ 80 Each bundle contains two faucet models and three pitcher models. So contribution margin of a bundle = 2 $60 + 3 $80 = $360 Breakeven point in units of faucet m odels and pitcher models is: Faucet models: 3,500 bundles 2 units per bundle = 7,000 units Pitcher models: 3,500 bundles 3 units per bundle = 10,500 units Total number of units to breakeven 17, 500 units Breakeven point in dollars for faucet models and pitcher models is: Faucet models: 7,000 units $150 per unit = $1,050,000 Pitcher models: 10,500 units $160 per unit = 1,680,000 Breakeven revenue s = $2,730,000   Breakeven Fixed costs $1, 260, 000 point in = 3, 500 bundles Contribution margin per bundle $360 bundles      EA 3-57 Breakeven point in dollars Faucet filter: 7,000 units $150 per unit = $1,050,000 Pitcher -cum -filter: 10,500 units $160 per unit = $1,680,000 2. Faucet filter: Sell ing price $150 Variable cost per unit 85 Contribution margin per unit $ 65 Pitcher -cum -filter: Selling price $160 Variable cost per unit 70 Contribution margin per unit $ 90 Each bundle contains two faucet models and three pitcher models. So contribution margin of a bundle = 2 $65 + 3 $90 = $400 Breakeven point in units of faucet models and pitcher models is: Faucet models: 3,750 bundles 2 units per bundle = 7,500 units Pitcher models: 3,750 bundles 3 units per bundle = 11,250 units Total number of units to breakeven: 18,750 units Breakeven point in dollars for faucet models and pitcher models is: Faucet mo dels: 7,500 bundles $150 per unit = $ 1125,000 Pitcher models: 11,250 bundles $160 per unit = 1,800,000 Breakeven revenues: $2,925,000 Breakeven point in dollars: (2 $60) + (3 $80) Alternatively, weighted average contribu tion margin per unit = = $72 5 $1,260,000 Breakeven point = 17, 500 units $72 2 Faucet filter: 17,500 units = 7,000 un its 5 3 Pitcher-cum-filter: 5    17, 500 units 10, 500 units      Breakeven Fixed costs $1, 260, 000 $240, 000 point in = 3, 750 bundles Contribution margin per bundle $400 bundles       (2 $65) + (3 $90) Alternatively, weighted average contribu tion margin per unit = = $80 5 $1,260,000 + $240,000 Breakeven point = 18, 750 units $80 2 Faucet filter: 18, 750 units = 7,500 un its 5 Pitcher-cum-    3 filter: 18, 750 units 11, 250 units 5 EA 3-58 Faucet filter: 7,500 units $150 per unit = $1,125,000 Pitcher -cum -filter: 11,250 units $160 per unit = $1,800,000 3. Let be the number of bundles for Romi Filters to be indifferent b etween the old and new production equipment. Operating income using old equipment = $360 – $1,260,000 Operating income using new equipment = $400 – $1,260,000 – $240,000 At point of indifference: $360 – $1,260,000= $400 – $1,500,000 $400 – $360 = $1,500,000 – $1,260,000 $40 = $240,000 = $240,000 ÷ $40 = 6 ,000 bundles Faucet models = 6,000 bundles 2 units per bundle = 12,000 units Pitcher models = 6,000 bundles 3 units per bundle = 18,000 units Total number of units: 30,000 units Let x be the number of bundles; When total sales are less than 30,000 units (6,000 bundles) Romi Filters is better off with the old equipment. When total sales are greater than 30,000 units (6,000 bundles) Romi Filters is better off buying the new equipment. At total sales of 28,000 units (5,600 bundles), Romi Filters should keep the old production equipment. Check $360 5,600 – $1,260,000 = $756,000 is greater than $400 5,600 –$1,500,000 = $740,000. 3-51 Sales mix , two products. The Stackpole Company retails two products: a standard and a deluxe version of a luggage ca rrier. The budgeted income statement for next period is as follows: Required: 1. Compute the breakeven point in units, assuming that the company a chieves its planned sales mix. 2. Compute the breakeven point in units (a) if only standard carriers are sold and (b) if only   x x x x x x x x x     EA 3-59 deluxe carriers are sold. 3. Suppose 250,000 units are sold but only 50,000 of them are deluxe. Compute the operating income. Comp ute the breakeven point in units. Compare your answer with the answer to requirement 1. What is the major lesson of this problem? SOLUTION (20 –25 min.) Sales mix, two products. 1. Sales of standard and deluxe carriers are in the ratio of 187,500 : 62,50 0. So for every 1 unit of deluxe, 3 ( 187,500 ÷ 62,500 ) units of standard are sold. Contribution margin of the bundle = 3  $10 + 1  $20 = $ 30 + $ 20 = $ 50 Breakeven point in bundles = = 4 5,000 bundles Breakeven poin t in units is: Standard carrier : 45,000 bundles × 3 unit s per bundle 135 ,000 units Deluxe carrier : 45,000 bundles × 1 unit per bundle 45,000 units Total number of units to breakeven 180,000 units Alternatively, Let Q = Number of units of Deluxe ca rrier to break even 3Q = Number of units of Standard carrier to break even Revenues – Variable costs – Fixed costs = Zero operating income $2 8(3Q) + $ 50Q – $1 8(3Q) – $30 Q – $2,250,000 = 0 $84 Q + $ 50Q – $54Q – $30 Q = $2,250,000 $5 0Q = $2,250,00 0 Q = 45,000 units of Deluxe 3Q = 135 ,000 units of Standard The breakeven point is 1 35 ,000 Standard units plus 4 5,000 Deluxe units, a total of 1 80,000 units. 2a. Unit contribution margins are: Standard: $2 8 – $1 8 = $ 10 ; Deluxe: $ 50 – $30 = $ 20 If only Standard carriers were sold, the breakeven point would be: $2,250,000  $10 = 2 25 ,000 units. 2b. If only Deluxe carriers were sold, the breakeven point would be: $2,250,000  $2 0 = 1 12,500 units = 200,000($10 ) + 50,000($ 20 ) – $2,250 ,000 = $ 2,000 ,000 + $ 1,000 ,000 – $2,25 0,000 = $ 750 ,000 $2, 250, 000 $50 3. Operating income = Contribution marg in of Standard + Contribution margin of Deluxe - Fixed costs EA 3-60 Sales of standard and deluxe carriers are in the ratio of 200 ,000 : 50,000. So for every 1 unit of deluxe, 4 (200 ,000 ÷ 50,000) units of standard are sold. Co ntribution margin of the bundle = 4  $10 + 1  $20 = $ 40 + $ 20 = $6 0 Breakeven point in bundles = = 37,500 bundles Breakeven point in units is: Standard carrier: 37,500 bundles × 4 units per bundle 150,000 units Del uxe carrier: 37,500 bundles × 1 unit per bundle 37,500 units Total number of units to breakeven 187,500 units Alternatively, Let Q = Number of units of Deluxe product to break even 4Q = Number of units of Standard product to break eve n $2 8(4Q) + $ 50Q – $1 8(4 Q) – $30 Q – $2,250 ,000 = 0 $112 Q + $ 50Q – $72 Q – $30 Q = $2,250,000 $60 Q = $2,250,000 Q = 37,500 units of Deluxe 4Q = 150,000 units of Standard The breakeven point is 150,000 Standard + 37,500 Deluxe, a total of 187,500 un its. The major lesson of this problem is that changes in the sales mix change breakeven points and operating incomes. In this example, the budgeted and actual total sales in number of units were identical, but the propor tion of the product having the hi gher contribution margin declined. Operating income suffered, falling from $ 875 ,000 to $ 750 ,000. Moreover, the breakeven point rose from 180,000 to 187 ,500 units. 3-52 Gross margin and contribution margin. The Garden Club is preparing for its annual meet ing in which a magic show will be shown to its contributing members only. Last year, out of 1,500 members, only 600 contributed for the magic show. Tickets for the show were $30 per attendee. The profit report for last year’s show follows. Ticket sales $18 ,000 Cost of magic show 20,000 Gross margin (2,000) Printing, invitations and paperwork 1,800 Profit / (loss) $(3,800) This year, the club committee does not want to lose money on the magic show due to poor attendance and to achieve this goal, the co mmittee analyzed last year’s costs. It found that of the $20,000 cost of the magic show, 40% was fixed costs and the remaining 60% was variable costs.

Of the $1,800 cost of printing, invitations and paperwork, 50% was fixed and 50% variable. Required : 1. Pre pare last year’s profit report using the contribution margin format. $2, 250, 000 $60 EA 3-61 2. The club committee is considering expanding this year’s magic show invitation list to include volunteer members (in addition to its contributing members). If the club committee expands the magic show invitation list, it expects an 80% increase in attendance. Calculate the effect this will have on the profitability of the show assuming that fixed costs will be the same as last year. SOLUTION (20 min.) Gross margin and contribution margin . 1. Ticket sales ($30 600 attendees) $18,000 Variable cost of magic show ($20 a 600 attendees) $12,000 Variable printing, invitations and paperwork ($1.5 b 600) 90 ,012,900 Contribution margin 5,100 Fixed cost of magic show 8,000 Fixed cost of printing, invitations and paperwork 900 8,900 Operating profit (loss) $ (3,800) a($20,000 60%)/600 attendees = $20/attendee b($1,800 50%)/600 attendees = $1.50/attendee 2. Ticket sales ($30 600 attendees 180%) $32,400 Variable cost of magic show ($20 1,080 attendees) $21,600 Variable printing, invitations and paperwork ($1.50 1,080) 1,620 23,220 Contribution margin 9,180 Fixed cost of magic show 8,000 Fixed cost of printing, invitations and paperw ork 900 8,900 Operating profit (loss) $ 280 3-53 Ethics, CVP analysis. Megaphone Corporation produces a molded plastic casing, M&M101, for many cell phones currently on the market. Summary data from its 2017 income statement are as follows: Joshua Kirby, Megaphone’s president, is very concerned about Megaphone Corporation’s poor profitability. He asks Leroy Gibbs, production manager, and Tony DiNunzo, controller, to see if there are ways to reduce costs. After 2 weeks, Leroy returns with a p roposal to reduce variable costs to 55% of revenues by reducing the costs Megaphone currently incurs for safe disposal of wasted plastic. Tony is concerned that this would expose the company to potential enviro nmental liabilities. He tells Leroy, ―We would need to estimate some of these potential environmental costs and include them in our analysis.‖ ―You can’t do that,‖ Leroy replies. ―We are not violating any laws. There is some possibility that we may have to incur environmental costs in the future, but if we bring it up now, this proposal will not go through because our senior management a lways assumes these          EA 3-62 costs to be larger than they turn out to be. The market is very tough, and we are in danger of shutting down the company and costing all of us our j obs. The only reason our competitors are making money is because they are doing exactly what I am proposing.‖ Required: 1. Calculate Megaphone Corporation’s breakeven revenues for 2017. 2. Calculate Megaphone Corporation’s breakeven revenues if variable c osts are 55% of revenues. 3. Calculate Megaphone Corporation’s operating income for 2017 if variable costs had been 55% of revenues. 4. Given Leroy Gibbs’s comments, what should Tony DiNunzo do? SOLUTION (30 min.) Ethics, CVP analysis. 1. Contribution m argin percentage = = = = 35 % Breakeven revenues = = = $5,400 ,000 2. If variable costs are 55 % of revenues, contribu tion margin percentage equals 45 % (100%  55 %) Breakeven revenues = = = $ 4,2 00,000 3. Revenues $5,0 00,000 Variable costs (0.55  $5,000,000) 2,75 0,000 Fixed costs 1,890 ,000 Operating income $ 360 ,000 4. Incorrect reporting of environmental costs with the goal of continuing operations is unethical. In assessing the situation, the specific ―Standards of Ethical Conduct for Management Accountants‖ (described in Exhibit 1 -7) that the management accountant shou ld consider are listed below. Revenues osts Revenues Variable c $5, 000, 000 $3, 250, 000 $5,000,000  $1,750,000 $5,000,000 p ercentage margin on Contributi costs Fixed $1,890,000 0.35 p ercentage margin on Contributi costs Fixed $1,890,000 0.45 EA 3-63 Competence Clear reports using relevant and reliable information should be prepared. Preparing reports on the basis of incorrect environmental costs to make the company’s performance look better than it is violates competence standards. It is unethical for DiNunzo not to report environmental costs to make the plant’s performance look good. Integrity The management accountant has a responsibility to avoid actual or apparent conflicts of interest and advise all appropriate par ties of any potential conflict. DiNunzo may be tempted to report lower environmental costs to please Kirby and Gibbs and save the jobs of his colleagues. This action, however, violates the responsibility for integrity. The Standards of Ethical Conduct requ ire the management accountant to communicate favorable as well as unfavorable information. Credibilit y The management accountant’s Standards of Ethical Conduct require that information should be fairly and objectively communicated and that all relevant in formation should be disclosed. From a management accountant’s standpoint, underreporting environmental costs to make performance look good would violate the standard of objectivity. DiNunzo should indicate to Gibbs that estimates of environmental costs a nd liabilities should be included in the analysis. If Gibbs still insists on modifying the numbers and reporting lower environmental costs, DiNunzo should raise the matter with Kirby or one of Gibbs ’s superiors. If after taking all these steps, there is co ntinued pressure to understate environmental costs, DiNunzo should consider resigning from the company and not engage in unethical behavior. ERRATA NOTE: There were revisions made to the question and the solution. Please refer to the figures in the questi on set here in the ISM. The print version will be corrected at reprinting. 3-54 Deciding where to produce. (CMA, adapted) Central térmica, Inc., produces the same power generator in two Spanish plants, a new plant in Los Barrios and an older plant in Ascó. The following data are available for the two plants. EA 3-64 All fixed costs per unit are calculated based on a normal capacity usage consisting of 240 working days. When the number of working days exceeds 240, overtime charges raise the variable manufacturing costs of additional units by $5.00 per unit in Los Barrios and $10.00 per unit in Ascó. Central térmica, Inc., is expected to produce and sell 240,000 power generators during the coming year. Wanting to take advantage of the higher operating income per u nit at Ascó, the company’s production manager has decided to manufacture 120,000 units at each plant, resulting in a plan in which Ascó operates at maximum capacity (400 units per day × 300 days) and Los Barrios operates at its normal volume (500 units per day × 240 days). Required : 1. Calculate the breakeven point in units for the Los Barrios plant and for the Ascó plant . 2. Calculate the operating income that would result from the production manager’s plan to produce 120,000 units at each plant. 3. Determine how the production of 240,000 units should be allocated between the Los Barrios and Ascó plants to maximize operating income for Central térmica, Inc. Show your calculations . SOLUTION (35 min.) Deciding where to produce. Los Barrios Ascó Selling price $200.00 $200.00 Variable cost per unit $80.00 $85.00 Manufacturing 0.00 0.00 Marketing and distribution 20.00 100.00 25.00 110 .00 Contribution margin per unit (CMU) $100.00 $90 .00 Fixed costs per unit Manufacturing 35 .00 27 .00 Marketing and distribution 30.00 65.00 24.00 51.00 Operating income per unit $35.00 $39 .00 CMU of normal production (as shown above) $100.00 $90 .00 CMU of overtime production 95.00 80 .00 ($100 - $5; $ 90 - $10) 1. Los Barrios Ascó Annual fixed costs = Fixed cost per unit Daily production rate Normal annual capacity ($65 500 units 240 days; $5 1 400 units 240 days) $7,800,000 $4,896,000 Breakeven volume = FC CMU of normal production ($7,800,000 $100; 78,000 units 54,40 0 units         EA 3-65 $4,896,000 90 ) 2. Units produced and sold 120,000 120,000 Normal annual volume (units) (500 × 240; 400 × 240) 120,000 96,000 Units over normal volume (needing overtime) 0 24,000 CM from normal production units (normal annual volume CMU normal production) (120,000 × $100; 96,000 × $90 ) $12,000,000 $8,640,000 CM from overtime production units (0; 24,0 00 $80) 0 1,92 0,000 Total contribution margin $12,000,000 10,560,000 Total fixed costs 7,800,000 4,896,000 Operating income $4,200,000 $5,664,000 Total operating income $9,864,000 3. The optimal production plan is to produce 150,000 un its at the Los Barrios plant and 90,000 units at the Ascó plant. The full capacity of the Los Barrios plant, 150,000 units (500 units × 300 days), should be used because the contribution from these units is higher at all levels of production than is the co ntribution from units produced at the Ascó plant. Operating income at optimum production level: Los Barrios : 120,000 × $100 $ 12,000,000 Los Barrios : 30,000 × ($100 – $5) 2,850,000 Ascó : 90,000 × $90 8,100,000 Total contribution margin 22,950,000 De duct total fixed costs 12,696,000 Operating income $ 10,254,000 The contribution margin is higher when 150,000 units are produced at the Los Barrios plant and 90,000 units at the Ascó plant. As a result, operating income will also be higher in this case because total fixed costs for the division remain unchanged regardless of the quantity produced at each plant. Try It 3 -1 Solution Equation Method: Operating income = ($500 × 2,000) – ($400 × 2,000) – $150,000 = $1,000,000 − $800,000 − $150,000 = $50,000 Contribution Method:    Selling Quantity of Variable cost Quantity of Fixed Operating price units sold per unit units sold costs in come                             EA 3-66 Rearranging the equation above, Contribution margin per unit = Selling price – Variable cost per unit = $500 – $400 = $100 Operating income = $100 × 2,000 – $150,000 = $50,00 0 Selling Variable cost Quantity of Fixed Ope rating price per unit units sold costs income Contribution margin Quantity of Fixed Opera ting per unit units sold costs income                     EA 3-67 Try It 3 -2 Solution (a) Recall the equation method (equation 1): Setting operating income equal to $0 and denoting quantity of output units that must be sold by Q, the breakeven number of units is Re call the contribution margin method (equation 2): At the breakeven point, operating income is by definition $0, and so, (Equ ation 3) Rearranging equation 3 and entering the data, (b) (Equ ation 1) We denote by Q the unknown quantity of units Bernard Windows must sell to earn an operating income of $100,0 00. Selling price is $5 00, variable cost per package is $400, fixe d costs are $150 ,000, and tar get operating income is $100,0 00. Substituting these values into equ ation 1, we have Alternatively, we could use equation 2, Selling Quantity of Variable cost Quantity of Fixed Operating price units sold per unit units sold costs in come                     $500 $400 $150, 000 $0 $100 $150, 000 $150, 000 $100 per unit 1, 500 units QQ Q Q          Contribution Quantity of Fixed costs Operating income margin per unit units sold      Contribution margin per unit Breakeven qu antity of units Fixed costs  Breakeven Fixed costs $150, 000 1, 500 units number of units Contribution margin per unit $100 per uni t    Breakeven revenues Breakeven number of un its Selling price 1, 500 units $500 per unit $750, 000     Selling Quantity of Variable cost Quantity of Fixed Operating price units sold per unit units sold costs in come                                 $500 $400 $150, 000 $100, 000 $100 $150, 000 $100, 000 $250, 000 $250, 000 $100 per unit 2, 500 units QQ Q Q             EA 3-68 (Equ ation 2) Given a target operating income ( $100,0 00 in this case), we can rearrange terms to get equation 4. (Equation 4) Revenues to earn an operating income of $100,000 is Revenues = Number of units required to be sold × Selling price 2,500 units × $500 = $1,250,000 Try It 3 -3 Solution In other words, to earn a target net income of $63,00 0, Bernard Windows ’s target operating income is $90,0 00. Proof: Target operating i ncome $90,0 00 Tax at 30% (0.3 0 $90,0 00) 27,00 0 Target net income $63,00 0 The key step is to take the target net income number and convert it into the correspon ding target operating income number. We can then use equation 1 to determine the ta rget operatin g income and substitute numbers from our Bernard Windows example. (Equ ation 1) Alternatively, we can calculate the number of units Bernard Windows must sell by using the contr ibution margin method an d equation 4: Contribution margin Quantity of Fixed Opera ting per unit units sold costs income      Quantity of units Fixed costs Target operating income required to be sold Contribution margin per unit   Quantity of units $150, 000 $100, 000 2, 500 units required to be sold $100 per unit   Target Target Target net income Tax rate operating income operating income Target net income (Target operating incom e) (1 Tax rate) Target net income $63, 000 Target operating income 1 Tax rate 1                  $90, 000 0.30    Selling Quantity of Variable cost Quantity of Fixed Operating price units sold per unit units sold costs in come                     $500 $400 $150, 000 $90, 000 $100 $240, 000 $240, 000 $100 per unit 2, 400 units QQ Q Q          EA 3-69 (Equation 4) Revenues to earn net income of $63,000 or equivalently operating income of $90,000 is Revenues = Number of units required to be sold × Selling price 2,400 units × $500 = $1,200,000 Try It 3 -4 Solution The margin of safety indicates that sales would have to decrease by 900 units and revenues by $450,000 before the breakeven point is reached. Sometimes margin of safety is expressed as a percentage: In our example, margin of safety percentage This result means that revenues would have to decrease substantially, by 60 %, to reach the breakeven revenues. The high margin of safety gives management of Bernard Windows conf idence that the company is unlikely to su ffer a loss. Try It 3 -5 Solution At any given level of sales , The following table shows the degree of operating leverage at sales of 2,50 0 units for the two options. Quantity of units Fixed costs Target operating income required to be sold Contribution margin per unit $150, 000 $90, 000 2, 400 units $100 per unit     Budgeted Breakeven Margin of safety $1, 200, 000 $750, 000 $450, 0 00 revenues revenues Margin of Budgeted Breakeven 2, 400 1, 500 900 units safety (in units) sales (units) sales (units)             Margin of safety in dollars Margin of safety percentage Budgeted or actual revenues  $450, 000 37.5% $1, 200, 000  Degree of Contribution margin operating leverage Operating income  EA 3-70 Option 1 No C ommission Option 2 5% Commi ssion 1. Selling price $ 50 0 $ 50 0 2. Variable cost ($400; $400 + 0.05 × $500 ) $ 400 $ 425 3. Contribution margin per unit $ 100 $ 75 4. Contribu tion margin (row 3 2,500 units) $250,000 $187,5 00 5. Fixed costs $150,000 $ 87,500 3. Operating income (from E xhibit 3 -5) $100,0 00 $100,0 00 4. Degree of operating leverage (row 2 row 3) These results indicate that, when sales are 2,50 0 units, a 1% change in sales and contribution mar gin will result in 2.5 % change in operating i ncome for Option 1. For Option 2 , a 1% change in sales and contribution margin will result in only a 1 .875 % change in operating income. The degree of operating leverage at a given level of sales helps ma nagers calculate the effect of sales fluctuations on operating income. Try It 3 -6 Solution We assume that the budget ed sales mix (2,50 0 units of Chad Windo ws sold for eve ry 1,00 0 units of Musk Windows sold, that is, a ratio of 5 :2) will not change at different levels of total unit sales. That is, we think of Bernard Windows selling a bundle of 5 units of Chad Windows and 2 units of Musk Windows . (Note that t his does not mean that Bernard Windows physically bundles the two products together into one big package.) Each bundle yie lds a contribution margin of $65 0, calculated as follows: Number of Units of Chad Windows and Musk Windows in Each Bundle Contributio n Margin per Unit for Chad Windows and Musk Wi ndows Contribution Margin of the Bu ndle Chad Windows 5 $10 0 $50 0 Musk Windows 2 75 15 0 Total $65 0 To compute the breakeven point, we calculate the number of bundles Bernard needs to sell. The breakeven point in units of Chad Windows and Musk Windows is as follows:   $250, 000 2.50 $100, 000  $187, 500 1.875 $100, 000  Breakeven Fixed costs $195, 000 point in 300 bundles Contribution margin per bundle $650 per bu ndle bundles    EA 3-71 Chad Windows : 300 bundles 5units per bu ndle 1,500 units Musk Windows : 300 bundles 2 units per bu ndle 60 0 units Total number of units to break even 2,100 units The breakeven point in dollars for Chad Windows and Musk Windows is as follows: Chad Windows : 1,500 units $5 00 per unit $750 ,000 Musk Windows : 60 0 units $35 0 per unit 210 ,000 Breakeven revenues $960 ,000 When there are multiple products , it is often convenient to use the contribution margin pe rcentage. Under this approach, Bernard also calculates the rev enues from selling a bundle of 5 units of Chad Windows and 2 units of Musk Windows : Number of Units of Chad Windows and Musk Windows in Each Bu ndle Selling Price for Chad Windows and Musk Windows Revenue of the Bundle Chad Windows 5 $5 00 $2,5 00 Musk Windows 2 35 0 700 Total $3,2 00 The breakeven point in units and dollars for Chad Windows and Musk Windows are as follows: Chad Windows: 300 bundles × 5 units per bundle = 1,500 units × $500 = $750,000 Musk Windows: 300 bundles × 2 units per bundle = 600 units × $350 = $210,000 Contribution margin Contribution margin of the bundle $650 0.203125, or 20.3125% percentage for Revenue of the bundle $3, 200 the bundle    Breakeven Fixed costs $195, 000 $960, 000 revenues Contribution margin % for the bundle 0.2031 25    Number of bundles Breakeven revenues $960, 000 required to be sold 300 bundles Revenue per bundle $3, 200 per bundle to break even   