Problem 5-19 Basic CVP Analysis; Graphing [LO1, LO2, LO4, LO6]

Shirts Unlimited operates a chain of shirt stores that carry many styles of shirts that are all sold at the same price. To
encourage sales personnel to be aggressive in their sales efforts, the company pays a substantial sales commission on each
shirt sold. Sales personnel also receive a small basic salary.
     The following worksheet contains cost and revenue data for Store 36. These data are typical of the company's many
outlets:

Per Shirt
  Selling price $ 40.00   

  Variable
expenses:
     Invoice cost $ 18.00   
     Sales
7.00   
commission

       Total variable
$ 25.00   
expenses

Annual
  Fixed expenses:
     Rent $ 80,000   
     Advertising 150,000   
     Salaries 70,000   

       Total fixed
$ 300,000   
expenses

     The company has asked you, as a member of its planning group, to assist in some basic analysis of
its stores and company policies.

Required:
1. Calculate the annual break-even point in dollar sales and in unit sales for Store 36. (Omit the "$" sign in your
response.)

  Break-even point in unit sales 20,000  shirts

  Break-even point in dollar sales 800,000
$ 

3. If 19,000 shirts are sold in a year, what would be Store 36's net operating income or loss?  (Input the amount as a
positive value. Omit the "$" sign in your response.)

  Net operating loss 15,000

$    

4. The company is considering paying the store manager of Store 36 an incentive commission of $3 per shirt (in addition to
 the salespersons' commissions). If this change is made, what will be the new break-even point in dollar sales and in unit
sales? (Omit the "$" sign in your response.)

  New break-even point in unit sales 25,000  shirts

  New break-even point in dollar sales 1,000,000
$ 

5. Refer to the original data. As an alternative to (4) above, the company is considering paying the store manager a $3
commission on each shirt sold in excess of the break-even point. If this change is made, what will be the store’s net
operating income or loss if 23,500 shirts are sold in a year? (Input the amount as a positive value. Omit the "$" sign
in your response.)

  Net operating income 42,000

$    

6. Refer to the original data. The company is considering eliminating sales commissions entirely in its stores and increasing
fixed salaries by $107,000 annually. If this change is made, what will be the new break-even point in dollar sales and in
unit sales in Store 36? (Omit the "$" sign in your response.)

  New break-even point in unit sales 18,500 shirts

  New break-even point in dollar sales 740,000
$ 

Explanation:
1.
Profit = (Unit CM × Q) − Fixed expenses
$0 = (($40 − $25) × Q) − $300,000
$0 = ($15 × Q) − $300,000
$15Q = $300,000
Q = $300,000 ÷ $15 per shirt
Q = 20,000 shirts

20,000 shirts × $40 per shirt = $800,000

3.
The simplest approach is:

     
  Break-even sales 20,000  shirts
  Actual sales 19,000  shirts
 
  Sales short of break-even 1,000  shirts
 

1,000 shirts × $15 contribution margin per shirt = $15,000 loss

4.
The variable expenses will now be $28 ($25 + $3) per shirt, and the contribution margin will be $12 ($40 − $28) per shirt.

Profit = Unit CM × Q − Fixed expenses

$0 = ($40 − $28) × Q − $300,000
 $0 = ($12) × Q − $300,000
$12Q = $300,000
Q = $300,000 ÷ $12 per shirt
Q = 25,000 shirts

25,000 shirts × $40 per shirt = $1,000,000 in sales

5.
The simplest approach is:

     
  Actual sales 23,500   shirts
  Break-even sales 20,000   shirts
 
  Excess over break-even
3,500   shirts
sales
 

3,500 shirts × $12 per shirt* = $42,000 profit

*$15 present contribution margin − $3 commission = $12 per shirt

6.
The new variable expense will be $18 per shirt (the invoice price).

Profit = Unit CM × Q − Fixed expenses

$0 = ($40 − $18) × Q − $407,000
$0 = ($22) × Q − $407,000
$22Q = $407,000
Q = $407,000 ÷ $22 per shirt
Q = 18,500 shirts

18,500 shirts × $40 shirt = $740,000 in sales

Problem 5-20 Basics of CVP Analysis; Cost Structure [LO1, LO3, LO4, LO5, LO6]
Memofax, Inc., produces memory enhancement kits for fax machines. Sales have been very erratic, with some months showing a
profit and some months showing a loss. The company's contribution format income statement for the most recent month is given
below:

  Sales (13,500 units at $20

$ 270,000   
per unit)
  Variable expenses 189,000   

  Contribution margin 81,000   

  Fixed expenses 90,000   

  Net operating loss $ (9,000)  

 
Required:
1. Compute the company's CM ratio and its break-even point in both units and dollars. (Omit the "%" and "$" signs in your
response.)
 
  CM ratio 30
 %  
  Break-even point in units 15,000
      
  Break-even point in dollars 300,000
$        

 
2. The sales manager feels that an $8,000 increase in the monthly advertising budget, combined with an intensified effort by the
sales staff, will result in a $70,000 increase in monthly sales. If the sales manager is right, what will the revised net operating
income or loss? (Use the incremental approach in preparing your answer.) (Omit the "$" sign in your response.)
 
  Net operating income is 4,000
$    
 
3. Refer to the original data. The president is convinced that a 10% reduction in the selling price, combined with an increase of
$35,000 in the monthly advertising budget, will double unit sales. What will the new contribution format income statement look
like if these changes are adopted? (Input all amounts as positive values. Omit the "$" sign in your response.)
 
Contribution Income Statement
  Sales 486,000
$    
  Variable expenses 378,000
  

  Contribution margin 108,000

  
  Fixed expenses 125,000
  

  Net operating income (loss) 17,000

$    

 
4. Refer to the original data. The company’s advertising agency thinks that a new package would help sales. The new package
being proposed would increase packaging costs by $0.60 per unit. Assuming no other changes, how many units would have to
be sold each month to earn a profit of $4,500? (Do not round intermediate calculations.)
 
  Sales units 17,500
  
 
5. Refer to the original data. By automating, the company could slash its variable expenses in half. However, fixed costs would
increase by $118,000 per month.
 
a. Compute the new CM ratio and the new break-even point in both units and dollars. (Do not round intermediate
calculations. Omit the "%" and "$" signs in your response.)
 
  CM ratio 65
 %  
  Break-even point in units 16,000
      
  Break-even point in dollars 320,000
 $        
  
b. Assume that the company expects to sell 20,000 units next month. Prepare two contribution format income statements, one
assuming that operations are not automated and one assuming that they are. (Omit the "$" and "%" signs in your
response.)
 
Not Automated

     Total       Per Unit      %      Total       Per Unit     %

  Sales 400,000 20 100 400,000 20 100
$     $  $     $    
  Variable expenses 280,000 14 70 140,000 7 35
        

  Contribution 120,000 6 30 260,000 13 65

margin    $     $    

  Fixed expenses 90,000 208,000

     

  Net operating 30,000 52,000

income (loss) $     $    

Explanation:
1.
The CM ratio is 30%.

Total   Per Unit Percentage

  Sales
(13,500 $ 270,000    $ 20    100%
units)
  Variable
189,000    14    70%
expenses

  Contribu
tion $ 81,000    $ 6    30%
margin

The break-even point is:

Profit = (Unit CM × Q) − Fixed expenses

$0 = (($20 − $14) × Q) − $90,000
$0 = ($6 × Q) − $90,000
$6Q = $90,000
Q = $90,000 ÷ $6 per unit
Q = 15,000 units

15,000 units × $20 per unit = $300,000 in sales

2.
  Incremental contribution margin:
    $70,000 increased sales × 30%
$ 21,000   
CM ratio
  Less: Increased fixed costs:
    Increased advertising cost 8,000   

  Increase in monthly net operating

$ 13,000   
income

Since the company presently has a loss of $9,000 per month, if the changes are adopted, the loss will turn into a profit of $4,000 per
month.

3.
Sales: (27,000 units × $18 per unit*) = $486,000
Fixed expenses: ($90,000 + $35,000) = $125,000

*$20 − ($20 × 0.10) = $18

4.
Profit = (Unit CM × Q) − Fixed expenses
$4,500 = (($20 − $14.60*) × Q) − $90,000
$4,500 = ($5.40 × Q) − $90,000
$5.40Q = $94,500
Q = $94,500 ÷ $5.40 per unit
Q = 17,500 units

*$14.00 + $0.60 = $14.60.

5.
a.
The new CM ratio would be:

Per Unit Percentage

  Sales $ 20        100%    
  Variable
7        35%    
expenses

  Contribution
$ 13        65%    
margin

The new break-even point would be:

Fixed expenses
Unit sales to break even =
Unit contribution margin

$208,000
=  = 16,000 units
$13 per unit

Fixed expenses
Dollar sales to break even =
CM ratio

$208,000
=  = $320,000 in sales
Problem 5-22: Sales Mix; Multiproduct Break-Even Analysis
Given:
Marlin Company, a wholesale distributor, has been operating for only a few months. The company sells
three products - sinks, mirrors, and vanities. Budgeted sales by product and in total for the coming
month are shown below:

Product
Sinks Mirrors Vanities Total
48% 20% 32% 100%
$240,000 100% $100,000 100% $160,000 100% $500,000 100%
72,000 30% 80,000 80% 88,000 55% 240,000 48%
$168,000 70% $20,000 20% $72,000 45% $260,000 52%
223,600
$36,400

Percentage of total sales

Sales

Variable expenses

Contribution margin

Fixed expenses
Net operating income

Break-even point in sales dollars = Fixed expenses / CM ratio = $223,600 / .52 = $430,000

As shown by these data, net operating income is budgeted at $36,400 for the month, and break-even sales at $430,000.
Assume that actual sales for the month total $500,000 as planned. Actual sales by product are:

Sinks

Mirrors

Vanities

Total

Required:
1
. Prepare a contribution format income statement for the month based on actual sales data.
 Percentage of total sales

Sales
Variable expenses
Contribution margin
Fixed expenses
Net operating income

2
. Compute the break-even point in sales dollars for the month, based on your actual data.

Break-even point in sales dollars = Fixed expenses / CM ratio = $223,600 / .43 = $520,000

3
. Considering the fact that the company met its $500,000 sales budget for the month, the president is shocked at
the results shown on your income statement in (1) above. Prepare a brief memo for the president explaining
why both the operating results and the break-even point in sales dollars are different from what was budgeted.

Although the company met its sales budget of $500,000 for the month, the mix of products sold changed significantly from
that budgeted. This change in sales mix is the reason that the budgeted NOI was not met, and that BE sales increased.

As shown by the data in the table below, sales shifted away from Sinks, which provides the greatest CM per dollar
of sales, and shifted strongly toward Mirrors, which provides the least CM per dollar of sales. Consequently, although
the company met its budgeted level of total sales, these sales provided considerably less CM than we had planned,
with a resulting decrease in NOI.

The company's overall CM ratio decreased to 43%, from a planned level of 52%. With less average CM per dollar of sales,
a greater level of sales had to be achieved to provide sufficient CM to cover fixed costs. Hence the rise in BE sales.

Problem 5-23 Sales Mix; Break-Even Analysis; Margin of Safety [LO7, LO9]
Puleva Milenario SA, a company located in Toledo, Spain, manufactures and sells two models of luxuriously
finished cutlery—Alvaro and Bazan. Present revenue, cost, and unit sales data for the two products appear below.
All currency amounts are stated in terms of euros, which are indicated by the symbol € .

  Alvaro Bazan
  Selling price per unit € 4.00    € 6.00   
  Variable expenses per unit € 2.40    € 1.20   
  Number of units sold monthly   200  units   80  units

Fixed expenses are €660 per month.

Required:
1. Assuming the sales mix above, do the following:

a. Prepare a contribution format income statement showing both euro and percent columns for each product
and for the company as a whole. (Input all amounts as positive values except losses which should be
indicated by minus sign. Omit the "€" and "%" signs in your response.)

  Alvaro Bazan
          %      
  Sales 800 100 480
€  € 
  Variable expenses 480 60 96

 
  Contribution margin 320 40 384
€  € 
  Fixed expenses
       
  Net operating income (loss)      

       

b. Compute the break-even point in euros for the company as a whole and the margin of safety in both euros and
percent of sales. (Round your "Margin of safety percentage" to 2 decimal places. Omit the "€" and "%" signs
in your response.)

   
  Break-even point in euros 1,200
€       
  Margin of safety in euros 80
€       
  Margin of safety percentage 6.25
% 

2. The company has developed another product, Cano, that the company plans to sell for €8 each. At this price, the
company expects to sell 40 units per month of the product. The variable expense would be €6 per unit. The company’s
fixed expenses would not change.

a. Prepare another contribution format income statement, including sales of Cano (sales of the other two products
 would not change). (Input all amounts as positive values except losses which should be indicated by minus sign.
Omit the "€" and "%" signs in your response.)

  Alvaro Bazan
          %         %         %         %
€ 
  Sales 800 100 480 100 100 1,600 100
€  €  320 €   

  Variable expenses 480 60 96 20 240 75 816 51

 
 
€ 
  Contribution margin 320 40 384 80 25 784 49
€  €  80  

  Fixed expenses 660

             
  Net operating income
            €  124
(loss)
             

b. Compute the company’s new break-even point in euros for the company as a whole and the new margin of safety in
both euros and percent of sales. (Round the "Break-even point in euros" to the nearest euro amount. Round
"per unit" costs to 2 decimal places and other intermediate calculations to the nearest euro. Round
the "Margin of safety percentage" to 2 decimal places. Omit the "€" and "%" signs in your response.)

   
  Break-even point in euros 1,347 ± 0.1%
€       
  Margin of safety in euros 253 ± 0.1%
€       
  Margin of safety percentage 15.81
%  

Problem 5-25 Break-Even Analysis; Pricing [LO1, LO4, LO6]

Detmer Holdings AG of Zurich, Switzerland, has just introduced a new fashion watch for which the company is trying to find an
optimal selling price. Marketing studies suggest that the company can increase sales by 5,000 units for each SFr2 per unit reduction
in the selling price. (SFr2 denotes 2 Swiss francs.) The company’s present selling price is SFr90 per unit, and variable expenses are
SFr60 per unit. Fixed expenses are SFr840,000 per year. The present annual sales volume (at the SFr90 selling price) is 25,000
units.

Required:
1. What is the present yearly net operating income or loss? (Input the amount as a positive value. Omit the "SFr" sign in your
response.)

  Net operating loss 90,000

SFr    

2. What is the present break-even point in units and in Swiss franc sales? (Omit the "SFr" sign in your response.)

  Break-even point in units 28,000

  
  Break-even point in Swiss franc sales 2,520,000
SFr    
3. Assuming that the marketing studies are correct, what is the maximum profit that the company can earn yearly? At how many
units and at what selling price per unit would the company generate this profit?(Omit the "SFr" sign in your response.)

  Maximum profit 160,000

SFr    
  Number of units 50,000
  
  Selling price 80
SFr    

4. What would be the break-even point in units and in Swiss franc sales using the selling price you determined in (3) above (i.e.,
the selling price at the level of maximum profits)? (Omit the "SFr" sign in your response.)

  Break-even point in units 42,000

  
  Break-even point in Swiss franc sales 3,360,000
SFr    

Explanation:
1.
     
  Sales (25,000 units × SFr 90 per unit) SFr 2,250,000   
  Variable expenses (25,000 units × SFr 60 per unit)   1,500,000   
 
  Contribution margin   750,000   
  Fixed expenses   840,000   
 
  Net operating loss SFr (90,000)  
 

2.
Fixed expenses
Unit sales to break even =
Unit contribution margin

  SFr 840,000
=   = 28,000 units
  SFr 30 per unit

28,000 units × SFr 90 per unit = SFr 2,520,000 to break even.

3.
Unit Unit Unit Total Net
Selling Variable Contribution Contribution Fixed Operating
Price Expense Margin Volume Margin Expenses Income (Loss)
(SFrs) (SFrs) (SFrs) (Units) (SFrs) (SFrs) (SFrs)
90 60 30 25,000 750,000         840,000 (90,000)    
88 60 28 30,000 840,000         840,000 0     
86 60 26 35,000 910,000         840,000 70,000     
84 60 24 40,000 960,000         840,000 120,000     
82 60 22 45,000 990,000         840,000 150,000     
 80 60 20 50,000 1,000,000         840,000 160,000     
78 60 18 55,000 990,000         840,000 150,000     

The maximum profit is SFr 160,000. This level of profit can be earned by selling 50,000 units at a selling price of SFr 80 per unit.

4.
At a selling price of SFr 80 per unit, the contribution margin is SFr 20 per unit. Therefore:

Fixed expenses
Unit sales to break even =
Unit contribution margin

  SFr 840,000
=
  SFr 20 per unit

 
=  42,000 units
 
42,000 units × SFr 80 per unit = SFr 3,360,000 to break even.

Problem 5-26 Changes in Cost Structure; Break-Even Analysis; Operating Leverage;

Margin of Safety [LO4, LO6, LO7, LO8]
Frieden Company's contribution format income statement for the most recent month is given below:

  Sales (40,000 units) $ 800,000

  Variable expenses 560,000

  Contribution margin 240,000

  Fixed expenses 192,000

  Net operating income $ 48,000

The industry in which Frieden Company operates is quite sensitive to cyclical movements in the economy. Thus, profits vary
considerably from year to year according to general economic conditions. The company has a large amount of unused capacity and
is studying ways of improving profits.

Required:
New equipment has come on the market that would allow Frieden Company to automate a portion of its operations. Variable
expenses would be reduced by $6 per unit. However, fixed expenses would increase to a total of $432,000 each month.
Prepare two contribution format income statements, one showing present operations and one showing how operations would
appear if the new equipment is purchased. (Input all amounts as positive values except losses which should be indicated
by minus sign. Omit the "$" and "%" signs in your response.)

Present
        Amount          Per Unit        %        Amount          Per Unit     %
800,000 100
  Sales $    20 800,000 20 100
$  % $     $  % 
 
  Variable expenses 560,000 14 70 320,000 8 40
               

  Contribution 30
240,000 6 480,000 12 60
margin    $  %    $  % 

  Fixed expenses 192,000 432,000

     

  Net operating 48,000 48,000

income (loss) $     $    
2. Refer to the income statements in (1) above. For both present operations and the proposed new operations, Compute:

a. The degree of operating leverage.

       Present        Proposed
  Degree of operating leverage 5 10
     

b. The break-even point in dollars. (Omit the "$" sign in your response.)

      Present      Proposed
  Break-even point in dollars 640,000 720,000
$     $    

c. The margin of safety in both dollar and percentage terms. (Omit the "$" and "%" signs in your response.)

      Present    Proposed
  Margin of safety in dollars 160,000 80,000
$       $        
  Margin of safety in percentage 20 10
 %  %  

3. Refer again to the data in (1) above. As a manager, what factor would be paramount in your mind in deciding whether to
purchase the new equipment? (Assume that ample funds are available to make the purchase.)
Cyclical movements in the economy
4. Refer to the original data. Rather than purchase new equipment, the marketing manager argues that the company’s marketing
strategy should be changed. Instead of paying sales commissions, which are included in variable expenses, the marketing
manager suggests that salespersons be paid fixed salaries and that the company invest heavily in advertising. The marketing
manager claims that this new approach would increase unit sales by 50% without any change in selling price; the company’s
new monthly fixed expenses would be $240,000; and its net operating income would increase by 25%. Compute the break-even
point in dollar sales for the company under the new marketing strategy. (Omit the "$" sign in your response.)

  New break even point in dollar sales 960,000

$   
Explanation:
1.
Variable expenses (Proposed): $14 – $6 = $8

2.
a.
Degree of operating leverage:

Present:
Contribution margin
Degree of operating leverage =
Net operating income

$240,000
= =5
$48,000
Proposed:
Contribution margin
Degree of operating leverage =
Net operating income

$480,000
= = 10
$48,000

b.
Dollar sales to break even:

Present:
Fixed expenses
Dollar sales to break even =
CM ratio

$192,000
= = $640,000
0.30
Proposed:
Fixed expenses
Dollar sales to break even =
CM ratio

$432,000
= = $720,000
0.60

c.
Margin of safety:

Present:

  Margin of safety = Actual sales – Break-even sales

     
  = $800,000 – $640,000 = $160,000
   Margin of safety Margin of safety in dollars
=
percentage Actual sales

  $160,000
= = 20%
  $800,000
Proposed:

  Margin of safety = Actual sales – Break-even sales

     
  = $800,000 – $720,000 = $80,000

  Margin of safety Margin of safety in dollars

=
percentage Actual sales

  $80,000
= = 10%
  $800,000

3.
The major factor would be the sensitivity of the company’s operations to cyclical movements in the economy. Because the new
equipment will increase the CM ratio, in years of strong economic activity, the company will be better off with the new equipment.
However, the company will be worse off with the new equipment in years in which sales drop. The fixed costs of the new
equipment will result in losses being incurred more quickly and they will be deeper. Thus, management must decide whether the
potential for greater profits in good years is worth the risk of deeper losses in bad years.

4.
No information is given in the problem concerning the new variable expenses or the new contribution margin ratio. Both of these
items must be determined before the new break-even point can be computed. The computations are:

New variable expenses:

Profit  = (Sales – Variable expenses) – Fixed expenses

$60,000**  = ($1,200,000* – Variable expenses) – $240,000
Variable expenses  = $1,200,000 – $240,000 – $60,000
   = $900,000

*New level of sales: $800,000 × 1.5 = $1,200,000

**New level of net operating income: $48,000 × 1.25 = $60,000

New CM ratio:

        
  Sales $ 1,200,000 100 %
  Variable
  900,000 75 %
expenses
 
  Contributi
$ 300,000 25 %
on margin
 

With the above data, the new break-even point can be computed:
 Fixed expenses $240,000
Dollar sales to break even = = = $960,000