Chapter 19 – Weygandt Financial and Managerial Accounting, 3e

Challenge Exercises

CE 19-1

Booth Company had sales in 2020 of $1,875,000 on 75,000 units. Variable costs totaled
$1,125,000 and fixed costs totaled $500,000.

A new raw material is available that will decrease the variable costs per unit by 20% (or $3.00).
However, to process the new raw material, fixed operating costs will increase by $125,000.
Management feels that two-thirds of the decline in the variable costs per unit should be passed
on to customers in the form of a sales price reduction. The marketing department expects that
this sales price reduction will result in a 4% increase in the number of units sold.

Instructions
(a) Prepare a projected CVP income statement for 2020 (1) assuming the changes have not
been made, and (2) assuming that changes are made as described.

(b) Before Booth Company had the chance to implement usage of the new raw material,
new industry specifications were announced and result in the following changes for the
Booth Company. Variable costs will increase by 15% per unit and fixed costs will
increase by $50,000. Management feels that a $3 per unit price increase is needed to
accommodate the cost increases. However, this will result in a 10% decrease in units
sold. Prepare a CVP income statement assuming these changes have been made.

(c) The marketing department suggests implementing an advertising promotion that would
increase variable costs by $.50 per unit but would retain the original sales volume of
75,000 units. Prepare a CPV income statement with these changes. Do you
recommend implementation of the advertising program? Why or why not?
CE 19-2

Tasty Time Cafeteria operates cafeteria food services in public buildings in the Midwest. Tasty
Time is contemplating a major change in its cost structure. Currently, all of their cafeteria lines
are staffed with hourly wage employees who hand serve the food to customers. Benson Riggs,
Tasty Time’s owner, is considering replacing the employees with an automated self-service
system. However, before making the change, Benson would like to know the consequences of
the change, since the volume of business varies significantly from location to location. Shown
below are the CVP income statements for each alternative.

Personal Service Automated Self-Service

System System ______
Sales $2,500,000 $2,500,000
Variable costs 1,875,000 1,125,000
Contribution margin $ 625,000 $1,375,000
Fixed costs 125,000 875,000
Net Income $ 500,000 $ 500,000

Instructions
(a) Determine the degree of operating leverage for each alternative.
(b) Which alternative would produce the higher net income if sales increased by $250,000?
(c) Using the margin of safety ratio, determine which alternative could sustain the greater
decline in sales before operating at a loss.
(d) Tasty Time’s vice president of finance has offered another option. He suggests a
different system that combines personal service at key points in the cafeteria line with a
less expensive automated self -service system for the other items. The financial
information on this system is given below:

Blended Service
System
Sales $2,500,000
Variable costs 1,500,000
Contribution margin $ 1,000,000
Fixed costs 500,000
Net Income $ 500,000

(1) Determine the degree of operating leverage for this option.

(2) How much would net income increase if sales increased by $250,000?
(3) Using the margin of safety ratio, how large of a decline in sales could this option
sustain before operating at a loss.
(4) Which option do you recommend for Tasty Time Cafeteria?