SEATWORK

COST-VOLUME-PROFIT ANALYSIS

1. Wow!, Inc., in business since 2008, makes swimwear for

professional athletes. Analysis of the firm’s financial records
for the current year reveals the following:

Average swimsuit selling price P70

Variable swimsuit expenses:
Direct material P28
Direct labor 12
Variable overhead 8
Annual fixed cost:
Selling P10,000
Administrative 24,000

The company’s tax rate is 40 percent. Samantha Waters, company

president, has asked you to help her answer the following
questions.

a. What is the break-even point in number of swimsuits and in pesos?

b. How much revenue must be generated to produce P40,000 of pre-
tax earnings?
How many swimsuits would this level of revenue represent?
c. How much revenue must be generated to produce P40,000 of after-
tax earnings?
How many swimsuits would this represent?
d. What amount of revenue would be necessary to yield an after-tax
profit equal to 20 percent of revenue?
e. Wow! Inc. is considering purchasing a faster sewing machine that
will save P6 per swimsuit in cost but will raise annual fixed
cost by P40,000. If the equipment is purchased, the company
expects to make and sell an additional 5,000 swimsuits. Should
the company make this investment?
f. A marketing consultant told Wow! Inc. managers that they could
increase the number of swimsuits sold by 30 percent if the
selling price was reduced by 10 percent and the company spent
P10,000 on advertising. The company has been selling 3,000
swimsuits. Should the company make changes advised by the
consultant?

2. Racine Tire Co. manufactures tires for all-terrain vehicles. The

tire sells for P60 and variable cost per tire is P30; monthly fixed
cost is P450,000.
a. What is the break-even point in units and sales price?
b. If Ronnie Rice, the company’s CEO wants the business to earn
pre-tax profit of 25 percent of revenues, how many tires must
be sold each month?
c. If the company is currently selling 20,000 tires monthly, what
is the degree of operating leverage?
d. If the company can increase sales volume by 15 percent above the
current level, what will be the increase in net income? What
will be the new net income?
 3. Tennessee Tonic makes a high energy protein drink. The selling
price per gallon is P7.20, and variable cost of production is
P4.32. the total fixed cost per year is P316,600. The company is
currently selling 125,000 gallons per year.
a. What is the margin of safety in gallons?
b. What is the degree of operating leverage?
c. If the company can increase sales in gallons by 30 percent, what
percentage increase will it experience in income?
d. If the company increases advertising by P41,200, sales in
gallons will increase by 15 percent. What will be the new break-
even point? The new degree of operating leverage?

4. The Lit Shoe Company produces its famous shoe, the Superlite that
sells for P60 per pair. Operating income for this year is as
follows:

Sales revenue (P60 per pair) P300,000

Variable cost (P25 per pair) 125,000
Contribution margin 175,000
Fixed cost 100,000
Operating income P 75,000

Lite Shoe Company would like to increase its profitability over

the next year by at least 25%. To do so, the company is
considering the following options:

1. Replace a portion of its variable labor with an automated

machining process. This would result in a 20% decrease in
variable cost per unit, but a 15% increase in fixed costs. Sales
would remain the same.
2. Spend P30,000 on a new advertising campaign, which would
increase sales by 20%
3. Increase both selling price by P10 per unit and variable costs
by P7 per unit using a higher quality leather material in the
production of its shoes. The higher priced shoe would cause
demand to drop by approximately 10%.
4. Add a second manufacturing facility which would double Lite’s
fixed costs, but would increase sales by 60%

Evaluate each of the alternative considered by Lite Shoes. Do any of

the options meet or exceed Lite’s targeted income of 25%. What would
Lite do?
5. Dillon, Jones and Kline Ltd. Is studying the acquisition of
two electrical component insertion systems for producing its
sole product, the universal gismo. Data relevant to the
systems follow:
Model A
Variable costs, P8.00 per unit
Annual fixed cost, P1,971,200

Model B
Variable costs, P6.40 per unit
Annual fixed costs, P2,227,200
The selling price is P32 per unit for the universal gismo, which is
subject to a 5 percent sales commission. (In the following
requirements, ignore income taxes.)

REQUIRED:
a. How many units must the company sell to break even if Model A is
selected?
b. Which of the two systems would be more profitable if sales and
production are expected to average 184,000 units per year?
c. Assume Model B requires the purchase of additional equipment that
is not reflected in the preceding figures. The equipment will cost
P900,000 and will be depreciated over a five-year life by the
straight-line method. How many units must the company sell to earn
P 1,912, 800 of income if B selected? As in requirement (b) sales
and production are expected to average 184,000 units per year.
d. Ignoring the information presented in requirement c at what volume
level will management be indifferent between acquisition of Model
A and Model B? in other words, at what volume level will annual
total cost of each system be equal? (Hint: at any given peso sales
volume level will be the same amount regardless of which model is
selected.)
 SEATWORK
PRODUCT COSTING

1. The following information is available for GOT’s new product line:

Sale price per unit P15

Variable manufacturing cost/unit of production 8
Total annual fixed manufacturing cost 25,000
Variable administration cost/unit 3
Total annual fixed & administrative expenses 15,000

There was no inventory at the beginning of the year. Normal capacity

is 12,500 units. During the year, 12,500 units were produced and
10,000 units were sold.

REQUIRED:
1. Ending inventory, assuming the use of direct costing.
2. Ending inventory, assuming the use of absorption costing.
3. Total variable cost charged to expense for the year, assuming
the use of direct costing.
4. Total fixed cost charged to expense for the year, assuming the
use of absorption costing.

2. Suits Company was organized just year ago. The results of the
company’s first year of operations are shown below (absorption
costing basis):

Suits Company
Income Statement

Sales (2,000 units) P135,000

Less: Cost of goods sold/variable cost:
Beginning inventory P 0
Cost of goods manufactured 105,000
Goods available for sale P 105,000
Ending inventory 21,000 84,000
Gross margin 51,000
Less: Selling and administrative expenses 42,000
Net income P 9,000

The company’s selling and administrative expenses consist of

P32,000 per year in fixed expenses and P5 per unit sold in variable
expenses. The company’s unit product cost is computed as follows:

Variable manufacturing cost P32

Fixed manufacturing overhead (based on 10
Normal capacity of 2,500 units)
Unit product cost 42

REQUIRED:
1. Redo the company’s income statement in the contribution format
using variable costing.
2. Reconcile any difference between the net income figure on your
variable costing income statement above.