Problem 1

Toy Company manufactures smiley balls. The company has a standard ball that sells for 25. At present, the standard ball
is manufactured in a small plant that relies heavily on direct labor workers. Thus variable costs are high totaling 15 per
ball. Last year, the company sold 30,000 balls with the following results:
Pesos Unit Cost Percentage
Sales (30,000 standard balls) 750,000 25 100%
Variable Costs (450,000) 15 60%
Contribution Margin 300,000 10 40%
Fixed Costs (210,000)
Income before Tax 90,000 3 12%
Income Tax (40%) (36,000)
Net Income 54,000

Required:
1. Compute the break-even point in units and in pesos.
a. BE in units = 210,000 / 10 = 21,000
b. BE in pesos = 210,000 / 0.40 = 525,000

Sales 525,000 (21,000 x 25)

VC – 60% (315,000)
CM 210,000
FxC (210,000)
PBT P0

Break-even point in Pesos = Fixed Cost + Desired Profit Before Tax

Contribution Margin Ratio
*Desired Profit Before Tax = Profit After Tax / (1 – Tax Rate)
**Contribution Margin Ratio = Contribution Margin / Sales

Break-even point in Units = Fixed Cost + Desired Profit Before Tax

Contribution Margin Per Unit

2. Compute the sales revenue required if the company desires to earn profit of 150,000 before tax.

Sales = (210,000 + 150,000) / 0.40 = 900,000

Sales 900,000
VC (540,000)
CM 360,000
FxC (210,000)
PBT 150,000
3. How many units must be sold if the company wants to increase its profit after tax to 66,000?
32,000 units
Sales in units = 210,000 + (66,000 / (0.6))
10
PBT = 110,000

Sales 800,000 (32,000 x 25)

VC (480,000)
CM 320,000
FxC (210,000)
PBT 110,000
Tax – 40% (44,000)
PAT 66,000

4. Last year, the company’s profit ratio (before tax) was 12%. If the company desires to increase this ratio to 15%, how
much sales revenue must be earned?

90,000 is 12%
112,500 is 15%

x= (210,000 + 0.15x)
0.40

0.40x = 210,000 + 0.15x

0.25x = 210,000
0.25 0.25

x = 840,000

S 840,000 806,250
VC (504,000) (483,750)
CM 336,000 322,500
FxC (210,000) (210,000)
PBT 126,000 15% 112,500 13.95%

5. Compute the sales revenue required if the company wants to earn an after-tax profit of 9.6% of such sales revenue.
x= 210,000 + (0.096 / 0.6)x
0.40

x= 210,000 + 0.16x
0.40
0.40x = 210,000 + 0.16x
0.24x = 210,000
0.24 0.24
x = 875,000

6. Last year, the company earned before tax profit of P3 per unit. If the company wants to improve this figure by P1, how
many additional units must be sold?

PBT 90,000 / 30,000 units = 3 per unit

Target 4 per unit
Target Sales in Units = 210,000 + 120,000
10
Sales in Units = 33,000 units
3,000 additional units

7. Refer to the original data. Compute the company’s margin of safety in units and in pesos. What is the margin of safety
ratio?
MS in Pesos = 750,000 – 525,000 = 225,000
MS in Units = 9,000 units

8. What is the company’s degree of operating leverage at last year’s level of sales?

9. Due to an increase in labor rates, the company estimates that variable costs will increase by P3 per ball next year. If this
takes place and the selling price per ball remains constant at 25, what will be the new CM ratio and break-even point in
balls?

10. Refer to the data in 9. If the expected change in variable costs takes place, how many balls will have to be sold next
year to earn the same before tax profit of 90,000 as last year?

11. Refer to the data in 9, the president of the company feels that the company must raise the selling price on the standard
balls. If the Toy Company wants to maintain the same CM ratio as last year, what selling price per ball must it charge next
year to cover the increased labor costs?

12. Refer to the original data. The company is discussing the construction of a new, automated plant to manufacture the
standard balls. The new plant would slash variable costs per ball by 40%, but it would cause fixed costs to double in
amount per year. If the new plant is built, what would be the company’s new CM ratio and new break-even point in balls?

13. Refer to the data in 12

a. If the new plant is built, how many balls will have to be sold next year to earn the same income (90,000) as last year?
b. Assuming that the new plant is built and that next year the company manufactures and sells 30,000 balls (the same
quantity as sold last year). Compute the degree of operating leverage.
c. If you were a member of top management, would you have voted in favor of constructing the new plant?

Problem 2
A company sells two products Product X and Product Y. Historically, the company has sold on average 200 units of
Product X and 600 units of Product Y. It incurs fixed costs of 3,600 per period. Pertinent data are as follows:
Product X Product Y
Selling Price 10 5
Contribution Margin per Unit 3 2

Required: Compute the break-even sales in units and pesos.

Product X Product Y Total

Contribution Margin per Unit 3 2
Sales Mix Ratio 1 3
Composite CM per Sale 3 6 9

BE Sales = 3,600 / 9 = 400 Sales If target PBT is 2,700

Product X 400 x 1 = 400 BE in units is 2,800 (700:2,100)
Product Y 400 x 3 = 1,200 1,600 units BE in Pesos is 17,500
BE Sales in Pesos (400 x 10) + (1,200 x 5) = 10,000 Pesos