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Problem #1: Basic Cost-Volume Profit (CVP) Analysis Stratford Company distributes a lighweight lawn chair that sells for $15 per unit. Variable costs are $6 per unit, and fixed costs total $180,000 annually. Required: Answer the following independent questions: 1. What is the product’s CM ratio? 2. Use the CM ratio to determine the break-even point in sales dollars. 3. The company estimates that sales will increase by $45,000 during the coming year due to increased demand. By how much should net operating income increase? 4. Assume that the operating results for last year were as follows: Sales $360,000 Variable Expenses 144,000 Contribution Margin $216,000 Fixed expenses 180,000 Net Operating Income $ 36,000 a. Compute the degree of operating leverage at the current level of sales. b. The president expects sales to increase by 15% next year. By how much should net operating income increase? 5. Refer to the original data. Assume that the company sold 28,000 units last year. The sales manager is convinced that a 10% reduction in the selling price, combined with a $70,000 increase in advertising expenditures, would cause annual sales in units to increase by 50%. Prepare two contributing format income statements, one showing the results of last year’s operations and one showing what the results of operations would be if these changes were made. Would you recommend that the company do as the sales manager suggests? Problem #2 Basics of CVP Analysis: Cost Structure 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 per unit) $270,000 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 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 be the effect on the company’s monthly net operating income or loss? (use the incremental approach in preparing your answer). 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 cause unit sales to double. What will the new contribution format income statement look like if these changes are adopted? 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? 5. Refer to the original data. By automating certain operations, the company could slash its variable expenses in ahlf. 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. 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. c. Would you recommend that the company automate its operations? Explain. SOLUTION TO PROBLEM NO.:1: REQUIREMENT NO.:1: PRODUCT'S CM RATIO: $ Selling price per unit 15 $ less:Variable cost per unit 6 $ CONTRIBUTION PER UNIT 9 Contribution margin ratio = Contribution margin per unit/Selling price per unit 60% REQUIREMENT NO.:2: Break-even point in total sales dollars= Fixed expenses/CM ratio $ Fixed expenses 180,000 CM ratio 60% $ Break-even point in total sales dollars 300,000 REQUIREMENT NO.:3: $ Increase in sales 45,000 $ less:Variable cost($45,000/$15)*$6 18,000 $ Increase in net operating income 27,000 REQUIREMENT NO.:4: $ a Sales 360,000 $ less:Variable expenses 144,000 $ Contribution Margin 216,000 $ Fixed expenses 180,000 $ Net Operating Income 36,000 Degree of Operating Leverage= Contribution Margin/Net Income 6 $ b Increase in sales @15% 54,000 $ Increase in variable expenses @15% 21,600 $ INCREASE IN NET OPERATING INCOME 32,400 REQUIREMENT NO.:5: INCOME STATEMENT BASED ON RESULTS OF LAST YEAR OPERATIONS a Sales in units 28,000 $ Selling price per unit 15 $ Sales 420,000 $ less:Variable expenses @ $6 per unit 168,000 $ CONTRIBUTION MARGIN 252,000 $ less:Fixed Expenses 180,000 $ NET OPERATING INCOME 72,000 b INCOME STATEMENT BASED ON CHANGES PROPOSED BY THE SALES MANAGER Sales in units(increase by 50%) 42000 $ Selling price (reduced by 10%) 13.50 $ Decrease in Unit contribution margin 7.50 Expected total contribution margin $ with lower selling price: 315,000 Present total contribution margin $ (28,000 units *9) 252,000 INCREMENTAL CONTRIBUTION $ MARGIN 63,000 Change in fixed costs: $ Less:Incremental advertising expense 70,000 $ Reduction in net income (7,000) COMPARATIVE INCOME STATEMENTS PRESENT 28,000 UNITS EXPECTED 42,000 UNITS TOTAL PER UNIT TOTAL PER UNIT DIFFERENCE $ $ $ $ $ Sales 420,000 15 567,000 13.50 147,000 $ $ $ $ $ less:Variable expenses 168,000 6 252,000 6 84,000 $ $ $ $ $ Contribution margin 252,000 9 315,000 7.50 63,000 $ $ $ less:Fixed expenses 180,000 250,000 70,000 $ $ $ Net Income 72,000 65,000 (7,000) Based on the comparative income statements it is evident that the suggestion of the sales manager will result in reduction of net income by $7,000. S0, the changes should not be made.
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