Managerial Accounting - Decision Making and Motivating Performance

Srikant M. Datar, Madhav V. Rajan

Chapter 3

Cost-Volume-Profit Analysis - all with Video Answers

Educators

Chapter Questions

Problem 1

Describe the assumptions underlying CVP analysis.

Ameer Said

Ameer Said

Numerade Educator

Problem 2

Describe three methods that managers can use to express CVP relationships.

Ameer Said

Numerade Educator

Problem 3

Why is it more accurate to describe the subject matter of this chapter as CVP analysis rather than as breakeven analysis?

Ameer Said

Numerade Educator

Problem 4

"CVP analysis is both simple and simplistic. If you want realistic analysis to underpin your decisions, look beyond CVP analysis." Do you agree? Explain.

Oluwadamilola Ameobi

Oluwadamilola Ameobi

Numerade Educator

Problem 5

Describe sensitivity analysis. How has the advent of the electronic spreadsheet affected the use of sensitivity analysis?

Ameer Said

Numerade Educator

Problem 6

Give an example of how a manager can decrease variable costs while increasing fixed costs.

Ameer Said

Numerade Educator

Problem 7

Give an example of how a manager can increase variable costs while decreasing fixed costs.

Ameer Said

Numerade Educator

Problem 8

What is operating leverage? How is knowing the degree of operating leverage helpful to managers?

Ameer Said

Numerade Educator

Problem 9

"There is no such thing as a fixed cost. All costs can be 'unfixed' given sufficient time." Do you agree? What is the implication of your answer for CVP analysis?

Ameer Said

Numerade Educator

Problem 10

"In CVP analysis, gross margin is a less-useful concept than contribution margin." Do you agree? Explain briefly.

Prashant Bana

Numerade Educator

Problem 11

CVP computations. Fill in the blanks for each of the following independent cases.$$
\begin{array}{r|c|c|c|c|c|c}
\hline \text { Case } & \text { Revenues } & \text { Variable Costs } & \text { Fixed Costs } & \text { Tolal Costs } & \text { Operating lncome } & \text { Contribution Margin Percentage } \\
\hline \text { a. } & & \$ 800 & & \$ 1,000 & \$ 1,500 & \\
\text { b. } & \$ 2,000 & & \$ 200 & & \$ 300 & \\
\text { c. } & \$ 500 & \$ 300 & & \$ 500 & & 75 \% \\
\hline
\end{array}
$$

Amany Waheeb

Numerade Educator

Problem 12

CVP exercises. The Delightful Donut owns and operates six doughnut outlets in and around Kansas City. You are given the following corporate budget data for next year:$$
\begin{array}{ll}
\text { Revenues } & \$ 10,500,000 \\
\text { Fixed costs } & \$ 1,400,000 \\
\text { Variable costs } & \$ 7,700,000
\end{array}
$$
Variable costs change based on the number of doughnuts sold.
Compute the budgeted operating income for each of the following deviations from the original budget data. (Consider each case independently.)
1. A $9 \%$ increase in contribution margin, holding revenues constant.
2. A $9 \%$ decrease in contribution margin, holding revenues constant.
3. A $3 \%$ increase in fixed costs.
4. A $3 \%$ decrease in fixed costs.
5. A $7 \%$ increase in units sold.
6. A $7 \%$ decrease in units sold.
7. A $9 \%$ increase in fixed costs and a $9 \%$ increase in units sold.
8. A $3 \%$ increase in fixed costs and a $3 \%$ decrease in variable costs.

Which of these alternatives yields the highest budgeted operating income? Explain why this is the case.

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Problem 13

CVP exercises. The Brewer Company manufactures and sells pens. Currently, $5,400,000$ units are sold per year at $$\$ 0.60$$ per unit. Fixed costs are $$\$ 860,000$$ per year. Variable costs are $$\$ 0.40$$ per unit.
Consider each case separately:
1a. What is the current annual operating income?
1b. What is the present breakeven point in revenues?
Compute the new operating income for each of the following changes:
2. $$A \$ 0.06$$ per unit increase in variable costs.
3. A $20 \%$ increase in fixed costs and a $20 \%$ increase in units sold.
4. A $40 \%$ decrease in fixed costs, a $40 \%$ decrease in selling price, a $30 \%$ decrease in variable cost per unit, and a $35 \%$ increase in units sold.

Compute the new breakeven point in units for each of the following changes:
5. A $20 \%$ increase in fixed costs
6. A $20 \%$ increase in selling price and a $$\$ 20,000$$ increase in fixed costs

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Problem 14

CVP analysis, income taxes. Diego Motors is a small car dealership. On average, it sells a car for $$\$ 30,000$$, which it purchases from the manufacturer for $$\$ 26,000$$. Each month, Diego Motors pays $$\$ 55,000$$ in rent and utilities and $$\$ 75,000$$ for salespeople's salaries. In addition to their salaries, salespeople are paid a commission of $$\$ 800$$ for each car they sell. Diego Motors also spends $$\$ 14,000$$ each month for local advertisements. Its tax rate is $40 \%$.
1. How many cars must Diego Motors sell each month to break even?
2. Diego Motors has a target monthly net income of $$\$ 59,520$$. What is its target monthly operating income? How many cars must the company sell each month to reach the target monthly net income of $$\$ 59,520$$ ?

Amany Waheeb

Numerade Educator

Problem 15

CVP analysis, sensitivity analysis. Tomas King is a new author for SingleDay Publishing. SingleDay Publishing is negotiating to publish Tomas's new book, which promises to be an instant best-seller. The fixed costs of producing and marketing the book will be $$\$ 575,000$$. The variable costs of producing and marketing will be $$\$ 4.50$$ per copy sold. These costs are before any payments to Tomas. Tomas negotiates an up-front payment of $$\$ 2.5$$ million, plus a $10 \%$ royalty rate on the net sales price of each book. The net sales price is the listed bookstore price of $$\$ 35$$, minus the margin paid to the bookstore to sell the book. The normal bookstore margin of $30 \%$ of the listed bookstore price is expected to apply.
1. Prepare a PV graph for SingleDay Publishing.
2. How many copies must SingleDay Publishing sell to (a) break even and (b) earn a target operating income of $$\$ 850,000$$ ?
3. Examine the sensitivity of the breakeven point to the following changes:
a. Increasing the royalty rate to $12 \%$ of the net sales price of each book.
b. Increasing the listed bookstore price to $$\$ 40$$ while keeping the royalty rate at $10 \%$.
c. Comment on the results and indicate which option you would prefer and why, indicating clearly any assumptions that you have made.

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Problem 16

CVP analysis, margin of safety. Suppose McKnight Corp.'s breakeven point is revenues of $$\$ 1,500,000$$. Fixed costs are $$\$ 720,000$$.
1. Compute the contribution margin percentage.
2. Compute the selling price if variable costs are $$\$ 13$$ per unit.
3. Suppose 85,000 units are sold. Compute the margin of safety in units and dollars.
4. What does this tell you about the risk of McKnight making a loss? What are the most likely reasons for this risk to increase?

Oluwadamilola Ameobi

Oluwadamilola Ameobi

Numerade Educator

Problem 17

Operating leverage. Curt Rugs is holding a two-week carpet sale at Josh's Club, a local warehouse store. Curt Rugs plans to sell carpets for $$\$ 850$$ each. The company will purchase the carpets from a local distributor for $$\$ 340$$ each, with the privilege of returning any unsold units for a full refund. Josh's Club has offered Curt Rugs two payment alternatives for the use of space.
- Option 1: A fixed payment of $$\$ 18,870$$ for the sale period
- Option 2: $20 \%$ of total revenues earned during the sale period

Assume Curt Rugs will incur no other costs.
1. Calculate the breakeven point in units for (a) option 1 and (b) option 2.
2. At what level of revenues will Curt Rugs earn the same operating income under either option?
a. For what range of unit sales will Curt Rugs prefer Option 1?
b. For what range of unit sales will Curt Rugs prefer Option 2?
3. Calculate the degree of operating leverage at sales of 185 units for the two rental options.
4. Briefly explain and interpret your answer to requirement 3 .

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Problem 18

Sales mix, new and upgrade customers. Record 1-2-3 is a top-selling electronic spreadsheet product. Record is about to release version 5.0 . It divides its customers into two groups: new customers and upgrade customers (those who previously purchased Record 1-2-3,4.0 or earlier versions). Although the same physical product is provided to each customer group, sizable differences exist in selling prices and variable marketing costs:
(TABLE CAN'T COPY)
The fixed costs of Record 1-2-3, 5.0 are $$\$ 16,500,000$$. The planned sales mix in units is $60 \%$ new customers and $40 \%$ upgrade customers.
1. What is the Record $1-2-3,5.0$ breakeven point in units, assuming that the planned $60 \%: 40 \%$ sales mix is attained?
2. If the sales mix is attained, what is the operating income when 220,000 total units are sold?
3. Show how the breakeven point in units changes with the following customer mixes:
a. New $40 \%$ and Upgrade $60 \%$
b. New $80 \%$ and Upgrade $20 \%$
c. Comment on the results.

Rahul Mahato

Numerade Educator

Problem 19

Sales mix, three products. The Janowski Company has three product lines of belts- $A, B$, and $C$ - with contribution margins of $$\$ 5, \$ 4$$, and $$\$ 3$$, respectively. The president foresees sales of 168,000 units in the coming period, consisting of 24,000 units of $A, 96,000$ units of $B$, and 48,000 units of $C$. The company's fixed costs for the period are $$\$ 405,000$$.
1. What is the company's breakeven point in units, assuming that the given sales mix is maintained?
2. If the sales mix is maintained, what is the total contribution margin when 168,000 units are sold? What is the operating income?
3. What would operating income be if the company sold 24,000 units of $A, 48,000$ units of $B$, and 96,000 units of $C$ ? What is the new breakeven point in units if these relationships persist in the next period?
4. Comparing the breakeven points in requirements 1 and 3 , is it always better for a company to choose the sales mix that yields the lower breakeven point? Explain.

Rahul Mahato

Numerade Educator

Problem 20

CVP, Not-for-profit. Madison Classical Music Society is a not-for-profit organization that brings guest artists to the community's greater metropolitan area. The Music Society just bought a small concert hall in the center of town to house its performances. The lease payments on the concert hall are expected to be $$\$ 4,000$$ per month. The organization pays its guest performers $$\$ 1,500$$ per concert and anticipates corresponding ticket sales to be $$\$ 4,500$$ per event. The Music Society also incurs costs of approximately $$\$ 1,600$$ per concert for marketing and advertising. The organization pays its artistic director $$\$ 30,000$$ per year and expects to receive $$\$ 29,000$$ per year in donations in addition to its ticket sales.
1. If the Madison Classical Music Society just breaks even, how many concerts does it hold each year?
2. In addition to the organization's artistic director, the Music Society would like to hire a marketing director for $$\$ 28,000$$ per year. What is the breakeven point? The Music Society anticipates that the addition of a marketing director would allow the organization to increase the number of concerts to 53 per year. What is the Music Society's operating income/(loss) if it hires the new marketing director?
3. The Music Society expects to receive a grant that would provide the organization with an additional $\$ 14,000$ toward the payment of the marketing director's salary. What is the breakeven point if the Music Society hires the marketing director and receives the grant?

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Problem 21

Contribution margin, decision making. Wharton Men's Clothing's revenues and cost data for 2012 are as follows:
$$
\begin{array}{lrr}
\text { Revenues } & & \$ 500,000 \\
\text { Cost of goods sold } & & 200,000 \\
\text { Gross margin } & & \\
\text { Operating costs: } & \$ 190,000 & \\
\quad \text { Salaries fixed } & 55,000 & \\
\text { Sales commissions (11\% of sales) } & 14,000 & \\
\text { Depreciation of equipment and fixtures } & 60,000 & \\
\text { Store rent (\$5,000 per month) } & \underline{35,000} & \underline{354,000} \\
\quad \text { Other operating costs } & & \underline{\underline{\$(54,000)}} \\
\text { Operating income (loss) } & &
\end{array}
$$
Mr. Wharton, the owner of the store, is unhappy with the operating results. An analysis of other operating costs reveals that it includes $$\$ 25,000$$ variable costs, which vary with sales volume, and $$\$ 10,000$$ fixed costs.
1. Compute the contribution margin of Wharton Men's Clothing.
2. Compute the contribution margin percentage.
3. Mr. Wharton estimates that he can increase revenues by $25 \%$ by incurring additional advertising costs of $$\$ 15,000$$. Calculate the impact of the additional advertising costs on operating income.
4. What other actions can Mr. Wharton take to improve operating income?

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Problem 22

Contribution margin, gross margin, and margin of safety. Sweet Aroma manufactures and sells scented oils to small specialty stores in the greater Dallas area. It presents the monthly operating income statement shown here to Hal Shaw, a potential investor in the business. Help Mr. Shaw understand Sweet Aroma's cost structure.
(TABLE CAN'T COPY)
1. Recast the income statement to emphasize contribution margin.
2. Calculate the contribution margin percentage and breakeven point in units and revenues for November 2012.
3. What is the margin of safety (in units) for November 2012 ?
4. If sales in November were only 7,500 units and Sweet Aroma's tax rate is $30 \%$, calculate its net income.

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Problem 23

Uncertainty and expected costs. (Appendix) Dawmart Corp., an international retail giant, is considering implementing a new business-to-business (B2B) information system for processing purchase orders. The current system costs Dawmart $$\$ 1,000,000$$ per month and $$\$ 45$$ per order. Dawmart has two options, a partially automated B2B and a fully automated B2B system. The partially automated B2B system will have a fixed cost of $$\$ 11,000,000$$ per month and a variable cost of $$\$ 25$$ per order. The fully automated B2B system has a fixed cost of $$\$ 19,000,000$$ per month and $$\$ 10$$ per order.
Based on data from the last 2 years, Dawmart has determined the following distribution on monthly orders:$$
\begin{array}{|c|c|}
\hline \text { Monthly Rumber of Orders } & \text { Probability } \\
\hline 400,000 & 0.10 \\
500,000 & 0.25 \\
600,000 & 0.45 \\
700,000 & 0.15 \\
800,000 & 0.05 \\
\hline
\end{array}
$$
1. Prepare a table showing the cost of each plan for each quantity of monthly orders.
2. What is the expected cost of each plan? Which plan would you recommend? Explain.
3. In addition to the information system costs, what other factors should Dawmart consider before deciding to implement a new B2B system?

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Problem 24

CVP analysis, service firm. Outback Escapes generates revenue of $$\$ 7,500$$ per person on its five-day package tours to wildlife parks in Kenya. The variable costs per person are as follows:$$
\begin{array}{lr}
\text { Airfare } & \$ 1,600 \\
\text { Hotel accommodations } & 3,100 \\
\text { Meals } & 600 \\
\text { Ground transportation } & 300 \\
\text { Park tickets and other costs } & \underline{700} \\
\text { Total } & \underline{\$ 6,300} \\
\hline
\end{array}
$$
Annual fixed costs total $$\$ 570,000$$.
1. Calculate the number of package tours that must be sold to break even.
2. Calculate the revenue needed to earn a target operating income of $$\$ 102,000$$.
3. If fixed costs increase by $$\$ 19,000$$, what decrease in variable cost per person must be achieved to maintain the breakeven point calculated in requirement 1 ?
4. The general manager at Outback Escapes proposes to increase the price of the package tour to $$\$ 8,200$$ to decrease the breakeven point. Using information in the original problem, calculate the new breakeven point. What factors should the general manager consider before deciding to increase the price of the package tour?

Rahul Mahato

Numerade Educator

Problem 25

CVP analysis, margin of safety. (CMA, adapted) Creative Solutions sells officeorganizing units for small businesses. The current selling price per unit is $$\$ 320$$. Operating income for 2012 is $$\$ 400,000$$ based on a sales volume of 12,000 units. Variable costs of producing the units are $$\$ 100$$ per unit sold plus an additional cost of $$\$ 20$$per unit for shipping and handling. Creative Solutions' annual fixed costs are $$\$ 2,000,000$$.
1. Calculate Creative Solutions' breakeven point and margin of safety in units in 2012.
2. In 2013 , management expects that the variable production cast per unit of the office-organizing units will increase by $20 \%$, but the shipping and handling costs per unit will decrease by $10 \%$. Calculate the Creative Solutions operating income in 2013 if the selling price remains unchanged, assuming all other data as in the original problem.
3. Under the assumptions made in requirement 2 , calculate the margin of safety in units. As a manager, would you be concerned? What actions, if any, might you consider taking in response and why?
4. Under the assumptions made in requirement 2 , how many units must Creative Solutions sell to earn the same operating income as in 2012?

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Problem 26

CVP analysis, income taxes. (CMA, adapted) J.T. Lu and Company, a manufacturer of quality handmade walnut bowls, has had a steady growth in sales for the past 5 years. However, increased competition has led Mr. Lu, the president, to believe that an aggressive marketing campaign will be necessary next year to maintain the company's present growth. To prepare for next year's marketing campaign, the company's controller has prepared and presented Mr. Lu with the following data for the current year, 2012:
$$
\begin{array}{|c|c|}
\hline \text { Variable cost (per bowl) } & \\
\hline \text { Direct materials } & 3.75 \\
\hline \text { Direct manufacturing labor } & 8.50 \\
\hline \text { Variable overhead (manufacturing, marketing, distribution, and customer service) } & 1.25 \\
\hline \text { Total variable cost per bowl } & \$ 13.50 \\
\hline \text { Fixed costs } & \\
\hline \text { Manufacturing } & \$ 14,000 \\
\hline \text { Marketing, distribution, and customer service } & 133,000 \\
\hline \text { Total fixed costs } & \$ 147,000 \\
\hline \text { Selling price } & 24.00 \\
\hline \text { Expected sales, } 20,000 \text { units } & \$ 480,000 \\
\hline \text { Income tax rate } & 40 \% \\
\hline
\end{array}
$$
1. What is the projected net income for 2012 ?
2. What is the breakeven point in units for 2012 ?
3. Mr. Lu has set the revenue target for 2013 at a level of $$\$ 540,000$$ (or 22,500 bowls). He believes an additional marketing cost of $$\$ 10,500$$ for advertising in 2013 , with all other costs remaining constant, will be necessary to attain the revenue target. What is the net income for 2013 if the additional $$\$ 10,500$$ is spent and the revenue target is met?
4. What is the breakeven point in revenues for 2013 if the additional $$\$ 10,500$$ is spent for advertising?
5. If the additional $$\$ 10,500$$ is spent, what are the required 2013 revenues for 2013 net income to equal 2012 net income?
6. At a sales level of 22,500 units, what maximum amount can be spent on advertising if a 2013 net income of $$\$ 47,100$$ is desired?

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Problem 27

CVP, sensitivity analysis. The Derby Shoe Company produces its famous shoe, the Divine Loafer, which sells for $$\$ 70$$ per pair. Operating income for 2012 is as follows:$$
\begin{array}{lr}
\text { Sales revenue (\$70 per pair) } & \$ 280,000 \\
\text { Variable cost } \$ 30 \text { per pair) } & 120,000 \\
\text { Contribution margin } & 160,000 \\
\text { Fixed cost } & \underline{80,000} \\
\text { Operating income } & \underline{\$ 80,000}
\end{array}
$$
Derby Shoe Company would like to increase its profitability over the next year by at least $25 \%$. To do so, the company is considering the following options:
1. Replace a portion of its variable labor with an automated machining process. This would result in a $15 \%$ decrease in variable cost per unit, but a $10 \%$ increase in fixed costs. Sales would remain the same.
2. Spend $$\$ 20,000$$ on a new advertising campaign, which would increase sales by $40 \%$.
3. Increase both selling price by $$\$ 10$$ per unit and variable costs by $$\$ 8$$ per unit by using a higher quality leather material in the production of its shoes. The higher priced shoe would cause demand to drop by $15 \%$.
4. Add a second manufacturing facility, which would double Derby's fixed costs but would increase sales by $60 \%$.

Evaluate each of the alternatives considered by Derby Shoes. Do any of the options meet or exceed Derby's targeted increase in income of $25 \%$ ? What should Derby do?

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Problem 28

CVP analysis, clothing stores. The Dress4Less Company operates a chain of men's clothing stores that sells 10 different styles of inexpensive men's suits with identical unit costs and selling prices. A unit is defined as one suit. Each store has a manager who is paid a fixed salary. Individual salespeople receive a fixed salary and a sales commission. Dress4Less is considering opening another store that is expected to have the revenue and cost relationships shown here:(TABLE CAN'T COPY)
Consider each question independently:
1. What is the annual breakeven point in (a) units sold and (b) revenues?
2. If 8,000 units are sold, what will be the store's operating income (loss)?
3. If sales commissions are discontinued and fixed salaries are raised by a total of $$\$ 90,000$$, what would be the annual breakeven point in (a) units sold and (b) revenues?
4. Refer to the original data. If, in addition to his fixed salary, the store manager is paid a commission of $$\$ 0.75$$ per unit sold, what would be the annual breakeven point in (a) units sold and (b) revenues?
5. Refer to the original data. If, in addition to his fixed salary, the store manager is paid a commission of $$\$ 0.75$$ per unit in excess of the breakeven point, what would be the store's operating income if 15,000 units were sold?

Oluwadamilola Ameobi

Oluwadamilola Ameobi

Numerade Educator

Problem 29

CVP analysis, shoe stores (continuation of 3-28). Refer to requirement 3 of Problem 3-28. In this problem, assume the role of the owner of Dress4Less.
1. Calculate the number of units sold at which the owner of Dress4Less would be indifferent betweer the original salary-plus-commissions plan for salespeople and the higher fixed-salaries-only plan.
2. As owner, which sales compensation plan would you choose if forecasted annual sales of the new store were at least 12,000 units? What do you think of the motivational effect on sales of your chosen compensation plan?
3. Suppose the target operating income is $$\$ 180,000$$. How many units must be sold to reach the target operating income under (a) the original salary-plus-commissions plan and (b) the higher-fixed-salaries-only plan? Which method would you prefer? Explain briefly.
4. You open the new store on January 1,2013 , with the original salary-plus-commission compensation plan in place. Because you expect the cost of the suits to rise due to inflation, you place a firm bulk order for 20,000 suits and lock in the $$\$ 120.00$$ price per unit. But, toward the end of the year, only 18,000 suits are sold, and you authorize a markdown of the remaining inventory to $$\$ 100$$ per unit. Finally, all units are sold. Salespeople, as usual, get paid a commission of $5 \%$ of revenues. What is the annual operating income for the store?

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Problem 30

Alternate cost structures, uncertainty, and sensitivity analysis. Integral Printing Company currently leases its only copy machine for $$\$ 1,200$$ a month. The company is considering replacing this leasing agreement with a new contract that is entirely commission based. Under the new agreement, Integral would pay a commission for its printing at a rate of $$\$ 20$$ for every 500 pages printed. The company currently charges $$\$ 0.15$$ per page to its customers. The paper used in printing costs the company $$\$ 0.04$$ per page and other variable costs, including hourly labor, amount to $$\$ 0.05$$ per page.
1. What is the company's breakeven point under the current leasing agreement? What is it under the new commission-based agreement?
2. For what range of sales levels will Integral prefer, (a) the fixed lease agreement or (b) the commission agreement?
3. Do this question only if you have covered the chapter appendix in your class. Integral estimates that the company is equally likely to sell 20,$000 ; 30,000 ; 40,000 ; 50,000 ; 60,000$ pages of print. Using information from the original problem, prepare a table that shows the expected profit at each sales level under the fixed leasing agreement and under the commission-based agreement. What is the expected value of each agreement? Which agreement should Integral choose?

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Problem 31

CVP, alternative cost structures. Crabapple Phones has just opened its doors. The new retail store sells refurbished phones at a significant discount from market prices. The phones cost Crabapple $$\$ 55$$ to purchase and require additional variable costs of $$\$ 45$$, which includes labor for refurbishing of $$\$ 35$$ and wages for sales personnel of $$\$ 10$$. The newly refurbished phones are resold to customers for $$\$ 150$$. Rent on the retail store costs the company $$\$ 5,000$$ per month.
1. How many phones does Crabapple have to sell each month to break even?
2. If Crabapple wants to eam $$\$ 4,000$$ per month after all expenses, how many phones does the company need to sell?
3. Crabapple can purchase already refurbished phones for $$\$ 77.50$$. This would mean that all labor required to refurbish the phones could be eliminated. What would Crabapple's new breakeven point be if it decided to purchase the phones already refurbished?
4. Instead of paying the monthly rental fee for the retail space, Crabapple has the option of paying its landlord a $20 \%$ commission on sales. Assuming the original facts in the problem, at what sales level would Crabapple be indifferent between paying a fixed amount of monthly rent and paying a $20 \%$ commission on sales?
5. What factors would you consider in deciding whether Crabapple should pay the monthly rental fee or the commission on sales?

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Problem 32

CVP analysis, income taxes, sensitivity. (CMA, adapted) Skudder Inc. sells blades that attach to garden tractors. For its 2013 budget, Skudder estimates the following:$$
\begin{array}{lr}
\text { Selling price } & \$ 750 \\
\text { Variable cost per engine } & \$ 350 \\
\text { Annual fixed costs } & \$ 750,000 \\
\text { Net income } & \$ 150,000 \\
\text { Income tax rate } & 25 \%
\end{array}
$$
The first-quarter income statement, as of March 31, reported that sales were not meeting expectations. During the first quarter, only 500 units had been sold at the current price of $$\$ 750$$. The income statement showed that variable and fixed costs were as planned, which meant that the 2013 annual net income projection would not be met unless management took action. A management committee was formed and presented the following mutually exclusive alternatives to the president:
a. Reduce the selling price by $20 \%$. The sales organization forecasts that at this significantly reduced price, 2,800 units can be sold during the remainder of the year. Total fixed costs and variable cost per unit will stay as budgeted.
b. Lower variable cost per unit by $$\$ 15$$ through the use of less-expensive direct materials. The selling price will also be reduced by $$\$ 100$$, and sales of 2,300 units are expected for the remainder of the year.
c. Reduce fixed costs by $20 \%$ and lower the selling price by $10 \%$. Variable cost per unit will be unchanged. Sales of 2,100 units are expected for the remainder of the year.
1. If no changes are made to the selling price or cost structure, determine the number of units that Skudder must sell (a) to break even and (b) to achieve its net income objective.
2. Determine which alternative Skudder should select to achieve its net income objective. Show your calculations.

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Problem 33

Choosing between compensation plans, operating leverage.
(CMA, adapted) Diem Corporation manufactures fertilizer products that are sold through a network of external sales agents. The agents are paid a commission of $20 \%$ of revenues. Diem is considering replacing the sales agents with its own salespeople, who would be paid a commission of $15 \%$ of revenues and total salaries of $$\$ 1,750,000$$. The income statement for the year ending December 31,2012 , under the two scenarios is shown here.
(TABLE CAN'T COPY)

1. Calculate Diem's 2012 contribution margin percentage, breakeven revenues, and degree of operating leverage under the two scenarios.
2. Describe the advantages and disadvantages of each type of sales alternative.
3. In 2013 , Diem uses its own salespeople, who demand an $18 \%$ commission. If all other cost behavior patterns are unchanged, how much revenue must the salespeople generate in order to earn the same operating income as in 2012?

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Problem 34

Multiproduct CVP and decision making. JumpUP Inc. produces two types of trampolines. One is smaller and is primarily used in gyms for exercise classes. The other is a larger model designed for recreational use.
The smaller trampoline sells for $$\$ 200$$ and has variable costs of $$\$ 120$$.
The larger trampoline sells for $$\$ 600$$ and has variable costs of $$\$ 420$$.

JumpUP sells four smaller models for every one larger model sold. Fixed costs equal $$\$ 1,250,000$$.
1. What is the breakeven point in unit sales and dollars for each type of trampoline at the current sales mix?
2. JumpUP is considering buying new production equipment. The new equipment will increase fixed cost by $$\$ 202,000$$ per year and will decrease the variable cost of the small and large trampolines by $$\$ 15$$ and $$\$ 45$$, respectively. Assuming the same sales mix, how many of each type of trampoline does JumpUP need to sell to break even?
3. Assuming the same sales mix, at what total sales level would JumpUP be indifferent between using the old equipment and buying the new production equipment? If total sales are expected to be 13,000 units, should JumpUP buy the new production equipment?

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Problem 35

Sales mix, two products. The Wharton Company retails two products: a standard and a deluxe version of a luggage carrier. The budgeted income statement for next period is as follows:$$
\begin{array}{l|r|r|r}
\hline & \text { Standard Carrier } & \text { Deluxe Carrier } & \text { Total } \\
\hline \text { Units sold } & \underline{180,000} & \underline{60,000} & \underline{\underline{240,000}} \\
\text { Revenues at } \$ 30 \text { and } \$ 38 \text { per unit } & \$ 5,400,000 & \$ 2,280,000 & \$ 7,680,000 \\
\text { Variable costs at } \$ 24 \text { and } \$ 28 \text { per unit } & \underline{4,320,000} & \underline{1,680,000} & \underline{6,000,000} \\
\text { Contribution margins at } \$ 6 \text { and } \$ 10 \text { per unit } & \underline{\underline{1,080,000}} & \underline{\$ 600,000} & 1,680,000 \\
\text { Fixed costs } & & & \underline{1,050,000} \\
\text { Operating income } & & & \underline{\$ 30,000} \\
\hline
\end{array}
$$
1. Compute the breakeven point in units, assuming that the company achieves its planned sales mix.
2. Compute the breakeven point in units (a) if only standard carriers are sold and (b) if only deluxe carriers are sold.
3. Suppose 240,000 units are sold but only 40,000 of them are deluxe. Compute the operating income. Compute the breakeven point in units. Compare your answer with the answer to requirement 1 . What is the major lesson of this problem?

Rahul Mahato

Numerade Educator

Problem 36

Ethics, CVP analysis. Freddie Corporation produces a molded plastic casing, LX201, for desktop computers. Summary data from its 2012 income statement are as follows:$$
\begin{array}{lr}
\text { Revenues } & \$ 3,000,000 \\
\text { Variable costs } & 2,100,000 \\
\text { Fixed costs } & 1,050,000 \\
\text { Operating income } & \underline{\$(150,000)}
\end{array}
$$
Terra Foreman, Freddie's president, is very concerned about Freddie Corporation's poor profitability. She asks Julian Vang, production manager, and Seth Madden, controller, to see if there are ways to reduce costs.

After 2 weeks, Julian returns with a proposal to reduce variable costs to $58 \%$ of revenues by reducing the costs Freddie currently incurs for safe disposal of wasted plastic. Seth is concerned that this would expose the company to potential environmental liabilities. He tells Julian, "We would need to estimate some of these potential environmental costs and include them in our analysis." "You can't do that," Julian replies. "We are not violating any laws. There is some possibility that we may have to incur environmental costs in the future, but if we bring it up now, this proposal will not go through because our senior management always assumes these costs to be larger than they turn out to be. The market is very tough, and we are in danger of shutting down the company, costing all of us our jobs. The only reason our competitors are making money is because they are doing exactly what I am proposing."
1. Calculate Freddie Corporation's breakeven revenues for 2012.
2. Calculate Freddie Corporation's breakeven revenues if variable costs are $58 \%$ of revenues.
3. Calculate Freddie Corporation's operating income for 2012 if variable costs had been $58 \%$ of revenues.
4. Given Julian Vang's comments, what should Seth Madden do?

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Problem 37

Deciding where to produce. (CMA, adapted) Portal Corporation produces the same laser printer in two Utah plants, a new plant in Ogden and an older plant in Sandy. The following data are available for the two plants:(TABLE CAN'T COPY)
All fixed costs per unit are calculated based on a normal capacity usage consisting of 240 working days. When the number of working days exceeds 240 , overtime charges raise the variable manufacturing costs of additional units by $$\$ 5.00$$ per unit in Ogden and $$\$ 10.00$$ per unit in Sandy.

Portal Corporation is expected to produce and sell 120,000 laser printers during the coming year. Wanting to take advantage of the higher operating income per unit at Sandy, the company's production manager has decided to manufacture 60,000 units at each plant, resulting in a plan in which Sandy operates at maximum capacity ( 200 units per day $\times 300$ days) and 0 gden operates at its normal volume ( 250 units per day $\times 240$ days).
1. Calculate the breakeven point in units for the Ogden plant and for the Sandy plant.
2. Calculate the operating income that would result from the production manager's plan to produce 60,000 units at each plant.
3. Determine how the production of 120,000 units should be allocated between the Ogden and Sandy plants to maximize operating income for Portal Corporation. Show your calculations.

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