Problem 1

Island Novelties, Inc., of Palau makes two products, Hawaiian Fantasy and Tahitian Joy. Present
revenue, cost, and sales data for the two products follow:

Fixed expenses total $475,800 per year.

Required:
1. Assuming the sales mix given above, do the following:
a) Prepare a contribution format income statement showing both dollar and percent columns
for each product and for the company as a whole.
b) Compute the break-even point in dollar sales for the company as a whole and the margin
of safety in both dollars and percent.

2. The company has developed a new product to be called Samoan Delight. Assume that the
company could sell 10,000 units at $45 each. The variable expenses would be $36 each. The
company’s fixed expenses would not change.
a) Prepare another contribution format income statement, including sales of the Samoan
Delight (sales of the other two products would not change).
b) Compute the company’s new break-even point in dollar sales and the new margin of
safety in both dollars and percent.

3. The president of the company examines your figures and says, “There’s something strange
here. Our fixed expenses haven’t changed and you show greater total contribution margin if we
add the new product, but you also show our break-even point going up. With greater contribution
margin, the break-even point should go down, not up. You’ve made a mistake somewhere.”
Explain to the president what has happened.
Problem 2

Casey Jones and two colleagues are considering opening a law office in a large metropolitan area
that would make inexpensive legal services available to those who could not otherwise afford
services. The intent is to provide easy access for clients by having the office open 360 days per
year, 16 hours each day from 7:00 a.m. to 11:00 p.m. The office would be staffed by a lawyer,
paralegal, legal secretary, and clerk-receptionist for each of the two eight-hour shifts.

In order to determine the feasibility of the project, Casey hired a marketing consultant to assist
with market projections. The results of this study show that if the firm spends $980,000 on
advertising the first year, the number of new clients expected each day will be 50. Casey and
associates believe this number is reasonable and are prepared to spend the $980,000 on
advertising. Other pertinent information about the proposed operation of the office follows:

The charge to each new client would be $60 for the initial consultation. All cases that warrant
further legal work will be accepted on a contingency basis with the firm earning 30 percent of
any favorable settlements or judgments. Casey estimates that 20 percent of new client
consultations will result in favorable settlements or judgments averaging $4,000 each. It is not
expected that there will be repeat clients during the first year of operations.

The hourly wages of the staff are projected to be $50 for the lawyer, $40 for the paralegal, $30
for the legal secretary, and $20 for the clerk-receptionist. Fringe benefit expense will be 40
percent of the wages paid. A total of 400 hours of overtime is expected for the year; this will be
divided equally between the legal secretary and the clerk-receptionist positions. Overtime will be
paid at one and one-half times the regular wage, and the fringe benefit expense will apply to the
full wage.

Casey has located 6,000 square feet of suitable office space which rents for $56 per square foot
annually. Associated expenses will be $54,000 for property insurance and $74,000 for utilities.It
will be necessary to purchase malpractice insurance, which is expected to cost $360,000
annually.

The initial investment in the office equipment will be $120,000. This equipment has an estimated
useful life of four years.

The cost of office supplies has been estimated to be $8 per expected new client consultation.

Required:
1. Determine how many new clients must visit the law office being considered by Casey and
colleagues for the venture to break even during its first year of operations.
2. Compute the proposed law firm's safety margin.
Problem 3
Eagle Bags produces messenger bags and backpacks in California. Eagle’s design team created a
new bag that includes a built-in power charge. The power charge can be used to recharge most
smart phones and tablet computers and is ideal for people who are constantly on the move. The
retail price of the new bag will be $229. The product is expected to be very popular. The
company has identified the following options to manufacture the new bags:
Option A: Eagle Bags outsources production of the new product to a third party at a cost of $180 per
unit (including labor and materials). There is negligible fixed cost if the bag is produced by a third party.
Option B: Eagle Bags makes the product in house, at $120 per unit (including labor and materials). The
company has to acquire additional sewing machines at a cost of $60,000 to produce the new product at its
existing facility.
Option C: Eagle Bags refurbishes one of its storage facilities with entirely new technology. The
company purchases numerically-controlled machines to manufacture the bags at $70 per unit (including
labor and materials). This option has a fixed cost of $220,000.
a)  Determine the range of production volume which makes Option A the lowest-cost option.
b)  Determine the range of production volume which makes Option B the lowest-cost option.
c)  Determine the range of production volume which makes Option C the lowest-cost option.

Problem 4.
The Eagle Insurance Company is considering opening a new office in Virginia. The two
locations under consideration are Richmond and Arlington. The managers have identified 5
factors that should be considered in decision making. Each location is assigned a score between 0
and 100 points on each factor. Higher scores are better. The scores are provided in the table
below.
a)  When factor weights are 0.25, 0.20, 0.20, 0.25, and 0.10 for customer convenience, bank accessibility,
computer support, rental costs, and labor costs, respectively, then which location is chosen by the factor-
weighting (factor rating) method?
b)  When factor weights are 0.40, 0.20, 0.10, 0.20, and 0.10 for customer convenience, bank accessibility,
computer support, rental costs, and labor costs, respectively, then which location is chosen by the factor-
weighting (factor rating) method?

Factor Richmond Arlington

Customer convenience 70 80

Bank accessibility 40 90

Computer support 85 75

Rental costs 90 55

Labor costs 80 50