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CHAPTER 7

Cost-Volume-Profit Analysis
ANSWERS TO REVIEW QUESTIONS
7-1

a. In the contribution-margin approach, the break-even point in units is calculated


using the following formula:

Break-even point

fixed expenses
unit contribution margin

b. In the equation approach, the following profit equation is used:


sales volume unit variable sales volume
unit
fixed

0
in units expense
in units expenses
sales price

This equation is solved for the sales volume in units.


c. In the graphical approach, sales revenue and total expenses are graphed. The
break-even point occurs at the intersection of the total revenue and total expense
lines.
7-2

The term unit contribution margin refers to the contribution that each unit of sales
makes toward covering fixed expenses and earning a profit. The unit contribution
margin is defined as the sales price minus the unit variable expense.

7-3

In addition to the break-even point, a CVP graph shows the impact on total expenses,
total revenue, and profit when sales volume changes. The graph shows the sales
volume required to earn a particular target net profit. The firm's profit and loss areas
are also indicated on a CVP graph.

7-4

The safety margin is the amount by which budgeted sales revenue exceeds breakeven sales revenue.

7-5

An increase in the fixed expenses of any enterprise will increase its break-even point.
In a travel agency, more clients must be served before the fixed expenses are
covered by the agency's service fees.

7-6

A decrease in the variable expense per pound of oysters results in an increase in the
contribution margin per pound. This will reduce the company's break-even sales
volume.

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7-1

7-7

The president is correct. A price increase results in a higher unit contribution margin.
An increase in the unit contribution margin causes the break-even point to decline.
The financial vice president's reasoning is flawed. Even though the break-even
point will be lower, the price increase will not necessarily reduce the likelihood of a
loss. Customers will probably be less likely to buy the product at a higher price.
Thus, the firm may be less likely to meet the lower break-even point (at a high price)
than the higher break-even point (at a low price).

7-8

When the sales price and unit variable cost increase by the same amount, the unit
contribution margin remains unchanged. Therefore, the firm's break-even point
remains the same.

7-9

The fixed annual donation will offset some of the museum's fixed expenses. The
reduction in net fixed expenses will reduce the museum's break-even point.

7-10

A profit-volume graph shows the profit to be earned at each level of sales volume.

7-11

The most important assumptions of a cost-volume-profit analysis are as follows:


(a) The behavior of total revenue is linear (straight line) over the relevant range. This
behavior implies that the price of the product or service will not change as sales
volume varies within the relevant range.
(b) The behavior of total expenses is linear (straight line) over the relevant range.
This behavior implies the following more specific assumptions:
(1) Expenses can be categorized as fixed, variable, or semivariable.
(2) Efficiency and productivity are constant.
(c) In multiproduct organizations, the sales mix remains constant over the relevant
range.
(d) In manufacturing firms, the inventory levels at the beginning and end of the
period are the same.

7-12

Operating managers frequently prefer the contribution income statement because it


separates fixed and variable costs. This format makes cost-volume-profit
relationships more readily discernible.

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Solutions Manual

7-13

The gross margin is defined as sales revenue minus all variable and fixed
manufacturing expenses. The total contribution margin is defined as sales revenue
minus all variable expenses, including manufacturing, selling, and administrative
expenses.

7-14

East Company, which is highly automated, will have a cost structure dominated by
fixed costs. West Company's cost structure will include a larger proportion of
variable costs than East Company's cost structure.
A firm's operating leverage factor, at a particular sales volume, is defined as its
total contribution margin divided by its operating income. Since East Company has
proportionately higher fixed costs, it will have a proportionately higher total
contribution margin. Therefore, East Company's operating leverage factor will be
higher.

7-15

When sales volume increases, Company X will have a higher percentage increase in
operating than Company Y. Company X's higher proportion of fixed costs gives the
firm a higher operating leverage factor. The company's percentage increase in
operating income can be found by multiplying the percentage increase in sales
volume by the firm's operating leverage factor.

7-16

The sales mix of a multiproduct organization is the relative proportion of sales of its
products.
The weighted-average unit contribution margin is the average of the unit
contribution margins for a firm's several products, with each product's contribution
margin weighted by the relative proportion of that product's sales.

7-17

The car rental agency's sales mix is the relative proportion of its rental business
associated with each of the three types of automobiles: subcompact, compact, and
full-size. In a multi-product CVP analysis, the sales mix is assumed to be constant
over the relevant range of activity.

7-18

Cost-volume-profit analysis shows the effect on profit of changes in expenses, sales


prices, and sales mix. A change in the hotel's room rate (price) will change the
hotel's unit contribution margin. This contribution-margin change will alter the
relationship between volume and profit.

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7-3

7-19

Budgeting begins with a sales forecast. Cost-volume-profit analysis can be used to


determine the profit that will be achieved at the budgeted sales volume. A CVP
analysis also shows how profit will change if the sales volume deviates from
budgeted sales.
Cost-volume-profit analysis can be used to show the effect on profit when
variable or fixed expenses change. The effect on profit of changes in variable or
fixed advertising expenses is one factor that management would consider in making
a decision about advertising.

7-20

The low-price company must have a larger sales volume than the high-price
company. By spreading its fixed expense across a larger sales volume, the low-price
firm can afford to charge a lower price and still earn the same profit as the high-price
company. Suppose, for example, that companies A and B have the following
expenses, sales prices, sales volumes, and profits.

Company A
Sales revenue:
350 units at $10 ..............................................
100 units at $20 ..............................................
Variable expenses:
350 units at $6 ................................................
100 units at $6 ................................................
Contribution margin.............................................
Fixed expenses ....................................................
Operating Profit ....................................................

Company B

$3,500
$2,000
2,100
$1,400
1,000
$ 400

600
$1,400
1,000
$ 400

7-21

The statement makes three assertions, but only two of them are true. Thus the
statement is false. A company with an advanced manufacturing environment
typically will have a larger proportion of fixed costs in its cost structure. This will
result in a higher break-even point and greater operating leverage. However, the
firm's higher break-even point will result in a reduced safety margin.

7-22

Activity-based costing (ABC) results in a richer description of an organization's cost


behavior and CVP relationships. Costs that are fixed with respect to sales volume
may not be fixed with respect to other important cost drivers. An ABC system
recognizes these nonvolume cost drivers, whereas a traditional costing system does
not.

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Solutions Manual

SOLUTIONS TO EXERCISES
EXERCISE 7-23 (25 MINUTES)

1
2
3
4

Sales
Revenue
$160,000a
80,000
120,000
110,000

Variable
Expenses
$40,000
65,000
40,000
22,000

Total
Contribution
Margin
$120,000
15,000
80,000
88,000

Fixed
Operating
Expenses Income
$30,000
$90,000
b
15,000
-030,000
50,000
50,000
38,000

Break-Even
Sales
Revenue
$40,000
80,000
45,000c
62,500d

Explanatory notes for selected items:


aBreak-even

sales revenue...............................................................................
Fixed expenses ................................................................................................
Variable expenses ...........................................................................................

$40,000
30,000
$10,000

Therefore, variable expenses are 25 percent of sales revenue.


When variable expenses amount to $40,000, sales revenue is $160,000.
b$80,000

is the break-even sales revenue, so fixed expenses must be equal to the


contribution margin of $15,000 and profit must be zero.
c$45,000

= $30,000 (2/3), where 2/3 is the contribution-margin ratio.

d$62,500

= $50,000/.80, where .80 is the contribution-margin ratio.

EXERCISE 7-24 (20 MINUTES)


1.

2.

Break-even point (in units) =

Contribution-margin ratio

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fixed expenses
unit contribution margin

$40,000
= 10,000 pizzas
$10 $6

unit contribution margin


unit sales price

$10 $6
= .4
$10
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7-5

EXERCISE 7-24 (CONTINUED)


3.

4.

Break-even point (in sales dollars)

fixed expenses
contribution-margin ratio

$40,000
= $100,000
.4

Let X denote the sales volume of pizzas required to earn a target operating income of
$80,000.
$10X $6X $40,000 = $80,000
$4X = $120,000
X = 30,000 pizzas

EXERCISE 7-25 (25 MINUTES)


1.

2.

3.

Break-even point (in units)

fixed costs
unit contribution margin

$4,000,000
= 4,000 components
$3,000 $2,000

New break-even point (in units)

($4,000,000) (1.10)
$3,000 $2,000

$4,400,000
= 4,400 components
$1,000

Sales revenue (5,000 $3,000)


................................................. $15,000,000
Variable costs (5,000 $2,000) ........................................................ 10,000,000
Contribution margin .........................................................................
5,000,000
Fixed costs ........................................................................................
4,000,000
Operating income ............................................................................. $ 1,000,000

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EXERCISE 7-25 (CONTINUED)


4.

New break-even point (in units) =

$4,000,000
$2,500 $2,000

= 8,000 components
5.

Analysis of price change decision:


Price
$3,000
$15,000,000
Sales revenue: (5,000 $3,000) ................................
(6,200 $2,500) ................................
10,000,000
Variable costs: (5,000 $2,000) ................................
(6,200 $2,000) ................................
Contribution margin....................................................5,000,000
Fixed expenses ...........................................................4,000,000
$ 1,000,000
Operating income (loss) .............................................

$2,500
$15,500,000
12,400,000
3,100,000
4,000,000
($900,000)

The price cut should not be made, since projected operating income will decline.

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7-7

EXERCISE 7-26 (25 MINUTES)


1.

Cost-volume-profit graph:

Dollars per year


Total revenue

$300,000

Total expenses

Break-even point:
20,000 tickets

$250,000

Profit
area
Variable
expense
(at 30,000
tickets)

$200,000

$150,000
Loss area
$100,000

Annual
fixed
expenses

$50,000

5,000

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7-8

10,000

15,000

20,000

25,000

Tickets
sold per
30,000 year

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Solutions Manual

EXERCISE 7-26 (CONTINUED)


2.

Stadium capacity ................................................


Attendance rate ...................................................
Attendance per game .........................................

10,000
50%
5,000

Break-even point (tickets) 20,000

4
Attendanceper game
5,000
The team must play 4 games to break even.

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7-9

EXERCISE 7-27 (25 MINUTES)


1.

Profit-volume graph:

Dollars per year


$150,000

$100,000

$50,000
Break-even point:
20,000 tickets
0

$(50,000)

5,000

10,000

15,000

Profit
area

20,000

25,000

Tickets sold
per year

Loss
area

$(100,000)
Annual fixed
expenses
$(150,000)
$(180,000)

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EXERCISE 7-27 (CONTINUED)


2.

Safety margin:
Budgeted sales revenue
(12 games 10,000 seats .30 full $10) .............................................
Break-even sales revenue
(20,000 tickets $10) ...............................................................................
Safety margin .................................................................................................

3.

$360,000
200,000
$160,000

Let P denote the break-even ticket price, assuming a 12-game season and 50 percent
attendance:
(12)(10,000)(.50)P (12)(10,000)(.50)($1) $180,000 = 0
60,000P = $240,000
P = $4 per ticket

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7-11

EXERCISE 7-28 (25 MINUTES)


1.

(a) Traditional income statement:


EUROPA PUBLICATIONS, INC.
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 20XX
Sales .........................................................................
Less: Cost of goods sold .........................................
Gross margin ...............................................................
Less: Operating expenses:
Selling expenses ............................................
Administrative expenses ...............................
Operating income ........................................................

$2,200,000
1,500,000
$ 700,000
$150,000
150,000

300,000
$ 400,000

(b) Contribution income statement:


EUROPA PUBLICATIONS, INC.
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 20XX
Sales .........................................................................
Less: Variable expenses:
Variable manufacturing..................................
Variable selling ...............................................
Variable administrative ..................................
Contribution margin ....................................................
Less: Fixed expenses:
Fixed manufacturing ......................................
Fixed selling ...................................................
Fixed administrative .......................................
Operating income ........................................................
2.

$2,200,000
$1,000,000
100,000
30,000
$ 500,000
50,000
120,000

1,130,000
$ 1,070,000

670,000
$ 400,000

contribution margin
operating income
$1,070,000

2.6
$400,000

Operating leverage factor (at $2,200,000 sales level)

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Solutions Manual

EXERCISE 7-28 (CONTINUED)


3.

percentage increase operating


Percentage increase in operating income


in sales revenue leverage factor

= 10% 2.6
= 26%
4.

Most operating managers prefer the contribution income statement for answering this
type of question. The contribution format highlights the contribution margin and
separates fixed and variable expenses.

EXERCISE 7-29 (30 MINUTES)


1.
Bicycle Type
High-quality
Medium-quality
2.

Sales
Price
$500
300

Unit
Variable Cost
$300 ($275 + $25)
150 ($135 + $15)

Unit
Contribution Margin
$200
150

Sales mix:
High-quality bicycles ........................................................................................
Medium-quality bicycles ...................................................................................

3.

Weighted-average unit
contribution margin

25%
75%

= ($200 25%) + ($150 75%)


= $162.50

4.

fixed expenses
weighted-average unit contribution margin
$65,000

400 bicycles
$162.50

Break-even point (in units)

Bicycle Type
High-quality bicycles
Medium-quality bicycles
Total

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Break-Even
Sales Volume
100 (400 .25)
300 (400 .75)

Sales Price
$500
300

Sales
Revenue
$ 50,000
90,000
$140,000

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7-13

EXERCISE 7-29 (CONTINUED)


5.

Target operating income:

$65,000 $48,750
$162.50
700 bicycles

Sales volume required to earn target operating income of $48,750

This means that the shop will need to sell the following volume of each type of
bicycle to earn the target operating income:
High-quality ...........................................................................
Medium-quality .....................................................................

175 (700 .25)


525 (700 .75)

EXERCISE 7-30 (30 MINUTES)


Answers will vary on this question, depending on the airline selected as well as the year of
the inquiry. All publicly-owned airlines disclose load factors; some disclose break-even
load factors. In a typical year, most airlines report a load factor of about 80% and a
breakeven load factor of around 65 percent, though it can vary quite dramatically from
company to company and year to year.
EXERCISE 7-31 (25 MINUTES)
1.

The following income statement, often called a common-size income statement,


provides a convenient way to show the cost structure.
Amount
Revenue ..............................................................
Variable expenses ..............................................
Contribution margin...........................................
Fixed expenses ..................................................
Operating income...............................................

$550,000
300,000
$250,000
200,000
$ 50,000

Percent
(rounded)
100.0
54.5
45.5
36.4
9.1

2.
Decrease in
Revenue
$55,000*

Contribution Margin
Percentage
45.5%

Decrease in
Operating Income
$25,025

*$55,000 = $550,000 10%


45.5%

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= $250,000/$550,000 (rounded; at full precision, decrease is $25,000)


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Solutions Manual

EXERCISE 7-31 (CONTINUED)

contribution margin
operating income
$250,000

5
$50,000

3.

Operating leverage factor (at revenueof $550,000)

4.

Percentage changein operating income

percentageincrease operating leverage


in revenue
factor

20 % 5
100%

EXERCISE 7-32 (10 MINUTES)


Revenue .......................................................
Less: Variable expenses...........................
Contribution margin ...................................
Less: Fixed expenses ...............................
Operating Income (loss) .............................

Requirement (1)
$660,000
360,000
$300,000
280,000
$ 20,000

Requirement (2)
$ 550,000
600,000
$ (50,000)
175,000
$ (225,000)

EXERCISE 7-33 (20 MINUTES)

fixed expenses
contribution margin ratio
$120,000

$600,000
.20

1.

Break - even volume of service revenue

2.

Target pre - tax income

target after - tax net income


1 tax rate
$48,000

$80,000
1 .40

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7-15

EXERCISE 7-33 (CONTINUED)

target after - tax net income


(1 t )

contribution margin ratio


$48,000
$120,000
1 .40 $1,000,000

.20
fixed expenses

3.

Service revenue required to earn


target after-tax income of $48,000

4.

A change in the tax rate will have no effect on the firm's break-even point. At the breakeven point, the firm has no profit and does not have to pay any income taxes.

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Solutions Manual

SOLUTIONS TO PROBLEMS
PROBLEM 7-34 (30 MINUTES)
1.

Break-even point in units, using the equation approach:


$16X ($10 + $2)X $600,000 = 0
$4X = $600,000
X =

$600,000
$4

= 150,000 units
2.

New projected sales volume = 200,000 110%


= 220,000 units
Operating income = (220,000)($16 $12) $600,000
= (220,000)($4) $600,000
= $880,000 $600,000 = $280,000

3.

Target operating income = $200,000 (from original problem data)


New disk purchase price = $10 130% = $13
Volume of sales dollars required:
Volume of sales dollars required

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fixed expenses target operating income


contribution - margin ratio
$600,000 $200,000
$800,000

$16 $13 $2
.0625
$16
$12,800,000

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7-17

PROBLEM 7-34 (CONTINUED)


4.

Let P denote the selling price that will yield the same contribution-margin ratio:

$16 $10 $2
P $13 $2

$16
P
.25

P $15
P

.25P P $15
$15 .75P
P $15/.75
P $20
Check: New contribution-margin ratio is:

$20 $15
.25
$20

5. In the electronic version of the solutions manual, press the CTRL key and click on the
following link: Build a Spreadsheet 07-34.xls

PROBLEM 7-35 (30 MINUTES)


1.

Break-even point in sales dollars, using the contribution-margin ratio:

fixed expenses
contribution - margin ratio
$180,000 $72,000
$252,000

$20 $8 $2
.5
$20
$504,000

Break - even point

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Solutions Manual

PROBLEM 7-35 (CONTINUED)


2.

Target operating income, using contribution-margin approach:

fixed expenses target operating income


unit contribution margin
$252,000 $180,000 $432,000

$20 $8 $2
$10
43,200 units

Sales units to earn operating income of $180,000

3.

New unit variable manufacturing cost

= $8 110%
= $8.80

Break-even point in sales dollars:


$252,000
$252,000

$20.00 $8.80 $2.00


.46
$20
$547,826 (rounded)

Break - even point

4.

Let P denote the selling price that will yield the same contribution-margin ratio:
$20.00 $8.00 $2.00
P $8.80 $2.00

$20.00
P
P $10.80
.5
P
.5P P $10.80
$10.80 .5P
P $10.80/.5
P $21.60

Check: New contribution-margin ratio is:


$21.60 $8.80 $2.00
.5
$21.60

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7-19

PROBLEM 7-36 (30 MINUTES)


1.

Unit contribution margin:


Sales price
Less variable costs:
Sales commissions ($64 x 5%) $ 3.20
System variable costs
16.00
Unit contribution margin..

$64.00
19.20
$44.80

Break-even point = fixed costs unit contribution margin


= $985,600 $44.80
= 22,000 units
2.

Model no. 4399 is more profitable when sales and production average 46,000 units.

Sales revenue (46,000 units x $64.00)...


Less variable costs:
Sales commissions ($2,944,000 x 5%)
System variable costs:
46,000 units x $16.00.
46,000 units x $12.80.
Total variable costs..
Contribution margin...
Less: Annual fixed costs..
Operating income...
3.

Model
No. 6754

Model
No. 4399

$2,944,000

$2,944,000

$ 147,200

$ 147,200

736,000
$ 883,200
$2,060,800
985,600
$1,075,200

588,800
$ 736,000
$2,208,000
1,113,600
$1,094,400

Annual fixed costs will increase by $90,000 ($450,000 5 years) because of straightline depreciation associated with the new equipment, to $1,203,600 ($1,113,600 +
$90,000). The unit contribution margin is $48 ($2,208,000 46,000 units). Thus:
Required sales = (fixed costs + target net profit) unit contribution margin
= ($1,203,600 + $956,400) $48
= 45,000 units

4.

Let X = volume level at which annual total costs are equal


$16.00X + $985,600 = $12.80X + $1,113,600
$3.20X = $128,000
X = 40,000 units

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Solutions Manual

PROBLEM 7-37 (35 MINUTES)


1.

Current income:
Sales revenue...
Less: Variable costs $ 924,000
Fixed costs. 2,280,000
Operating income..

$3,360,000
3,204,000
$ 156,000

Advanced Electronics has a contribution margin of $58 [($3,360,000 - $924,000)


42,000 sets] and desires to increase income to $312,000 ($156,000 x 2). In addition,
the current selling price is $80 ($3,360,000 42,000 sets). Thus:
Required sales = (fixed costs + target net profit) unit contribution margin
= ($2,280,000 + $312,000) $58
= 44,690 sets (rounded), or $3,575,200 (44,690 sets x $80)
2.

If operations are shifted to Slovakia, the new unit contribution margin will be $64
($80 - $16). Thus:
Break-even point = fixed costs unit contribution margin
= $1,984,000 $64
= 31,000 units

3.

(a)
Advanced Electronics desires to have a 31,000-unit break-even point with a
$58 unit contribution margin. Fixed cost must therefore drop by $482,000
($2,280,000 - $1,798,000), as follows:
Let X = fixed costs
X $58 = 31,000 units
X = $1,798,000
(b)

As the following calculations show, Advanced Electronics will have to


generate a contribution margin of $73.55 to produce a 31,000-unit break-even
point. Based on an $80.00 selling price, this means that the company can
incur variable costs of only $6.45 per unit. Given the current variable cost of
$22.00 ($80.00 - $58.00), a decrease of $15.55 per unit ($22.00 - $6.45) is
needed.
Let X = unit contribution margin
$2,280,000 X = 31,000 units
X = $73.55 (rounded)

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7-21

PROBLEM 7-37 (CONTINUED


4.

(a)

Increase

(b)

No effect

(c)

Increase

(d)

No effect

PROBLEM 7-38 (40 MINUTES)


1.

Sales mix refers to the relative proportion of each product sold when a company
sells more than one product.

2.

(a)

Yes. Plan A sales are expected to total 65,000 units (45,500 + 19,500), which
compares favorably against current sales of 60,000 units.

(b)

Yes. Sales personnel earn a commission based on gross dollar sales. As the
following figures show, Deluxe sales will comprise a greater proportion of
total sales under Plan A. This is not surprising in light of the fact that Deluxe
has a higher selling price than Basic ($86 vs. $74).
Current
Units

Sales
Mix

Deluxe... 39,000 65%


Basic. 21,000 35%
Total
60,000 100%
(c)

Plan A
Units

Sales
Mix

45,500 70%
19,500 30%
65,000 100%

Yes. Commissions will total $535,600 ($5,356,000 x 10%), which compares


favorably against the current flat salaries of $400,000.
Deluxe sales: 45,500 units x $86 $3,913,000
Basic sales: 19,500 units x $74.. 1,443,000
Total. $5,356,000

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2011 The McGraw-Hill Companies, Inc.


Solutions Manual

PROBLEM 7-38 (CONTINUED)


(d)

No. The company would be less profitable under the new plan.
Sales revenue:
Deluxe: 39,000 units x $86; 45,500 units x $86
Basic: 21,000 units x $74; 19,500 units x $74..
Total revenue.
Less variable cost:
Deluxe: 39,000 units x $65; 45,500 units x $65
Basic: 21,000 units x $41; 19,500 units x $41..
Sales commissions (10% of sales revenue).
Total variable cost
Contribution margin..
Less fixed cost (salaries).
Operating income....

3.

(a)

Current

Plan A

$3,354,000
1,554,000
$4,908,000

$3,913,000
1,443,000
$5,356,000

$2,535,000
861,000

$2,957,500
799,500
535,600
$4,292,600
$1,063,400
---$1,063,400

$3,396,000
$1,512,000
400,000
$1,112,000

The total units sold under both plans are the same; however, the sales mix
has shifted under Plan B in favor of the more profitable product as judged by
the contribution margin. Deluxe has a contribution margin of $21 ($86 - $65),
and Basic has a contribution margin of $33 ($74 - $41).
Plan A
Units

Sales
Mix

Deluxe... 45,500 70%


Basic. 19,500 30%
Total 65,000 100%

McGraw-Hill/Irwin
Managerial Accounting, 9/e Global Edition

Plan B
Units

Sales
Mix

26,000 40%
39,000 60%
65,000 100%

2011 The McGraw-Hill Companies, Inc.


7-23

PROBLEM 7-38 (CONTINUED)


(b)

Plan B is more attractive both to the sales force and to the company.
Salespeople earn more money under this arrangement ($549,900 vs. $400,000)
and the company is more profitable ($1,283,100 vs. $1,112,000).
Sales revenue:
Deluxe: 39,000 units x $86; 26,000 units x $86
Basic: 21,000 units x $74; 39,000 units x $74..
Total revenue.
Less variable cost:
Deluxe: 39,000 units x $65; 26,000 units x $65
Basic: 21,000 units x $41; 39,000 units x $41..
Total variable cost
Contribution margin..
Less: Sales force compensation:
Flat salaries...
Commissions ($1,833,000 x 30%)
Operating Income ...

Current

Plan B

$3,354,000
1,554,000
$4,908,000

$2,236,000
2,886,000
$5,122,000

$2,535,000
861,000
$3,396,000
$1,512,000

$1,690,000
1,599,000
$3,289,000
$1,833,000

400,000
$1,112,000

549,900
$1,283,100

PROBLEM 7-39 (35 MINUTES)


1.

Plan A break-even point = fixed costs unit contribution margin


= $34,100 $31*
= 1,100 units
Plan B break-even point = fixed costs unit contribution margin
= $72,000 $40**
= 1,800 units
* $90 - [($90 x 10%) + $50]
** $90 - $50

2.

Operating leverage refers to the use of fixed costs in an organizations overall cost
structure. An organization that has a relatively high proportion of fixed costs and
low proportion of variable costs has a high degree of operating leverage.

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2011 The McGraw-Hill Companies, Inc.


Solutions Manual

PROBLEM 7-39 (CONTINUED)


3.

Calculation of contribution margin and profit at 6,000 units of sales:

Sales revenue: 6,000 units x $90.


Less variable costs:
Cost of purchasing product:
6,000 units x $50.
Sales commissions: $540,000 x 10%...
Total variable cost..
Contribution margin
Fixed costs.
Net income.

Plan A

Plan B

$540,000

$540,000

$300,000
54,000
$354,000
$186,000
34,100
$151,900

$300,000
---$300,000
$240,000
72,000
$168,000

Operating leverage factor = contribution margin net income


Plan A: $186,000 $151,900 = 1.22 (rounded)
Plan B: $240,000 $168,000 = 1.43 (rounded)
Plan B has the higher operating leverage factor.
4 & 5. Calculation of profit at 5,000 units:
Sales revenue: 5,000 units x $90.
Less variable costs:
Cost of purchasing product:
5,000 units x $50..
Sales commissions: $450,000 x 10%...
Total variable cost..
Contribution margin
Fixed costs
Net income.

Plan A

Plan B

$450,000

$450,000

$250,000
45,000
$295,000
$155,000
34,100
$120,900

$250,000
---$250,000
$200,000
72,000
$128,000

Plan A profitability decrease:


$151,900 - $120,900 = $31,000; $31,000 $151,900 = 20.4% (rounded)
Plan B profitability decrease:
$168,000 - $128,000 = $40,000; $40,000 $168,000 = 23.8% (rounded)

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2011 The McGraw-Hill Companies, Inc.


7-25

PROBLEM 7-39 (CONTINUED)


Consolidated would experience a larger percentage decrease in income if it adopts
Plan B. This situation arises because Plan B has a higher degree of operating
leverage. Stated differently, Plan Bs cost structure produces a greater percentage
decline in profitability from the drop-off in sales revenue.
Note: The percentage decreases in profitability can be computed by multiplying the
percentage decrease in sales revenue by the operating leverage factor. Sales
dropped from 6,000 units to 5,000 units, or 16.67%. Thus:
Plan A: 16.67% x 1.22 = 20.3% (difference due to rounding)
Plan B: 16.67% x 1.43 = 23.8% (rounded)
6.

Heavily automated manufacturers have sizable investments in plant and equipment,


along with a high percentage of fixed costs in their cost structures. As a result,
there is a high degree of operating leverage.
In a severe economic downturn, these firms typically suffer a significant
decrease in profitability. Such firms would be a more risky investment when
compared with firms that have a low degree of operating leverage. Of course, when
times are good, increases in sales would tend to have a very favorable effect on
earnings in a company with high operating leverage.

McGraw-Hill/Irwin
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2011 The McGraw-Hill Companies, Inc.


Solutions Manual

PROBLEM 7-40 (30 MINUTES)


fixed costs
unit contribution margin
$468,000

90,000 units
$25.00 $19.80

1.

Break - even point (in units)

2.

Break - even point (in sales dollars)

3.

Number of sales units required to


earn target operating income

4.

Margin of safety = budgeted sales revenue break-even sales revenue

fixed cost
contribution - margin ratio
$468,000

$2,250,000
$25.00 $19.80
$25.00
fixed costs target operating income
unit contribution margin
$468,000 $260,000

140,000 units
$25.00 $19.80

= (120,000)($25) $2,250,000 = $750,000


5.

Break-even point if direct-labor costs increase by 8 percent:


New unit contribution margin

= $25.00 $6.00 ($5.00)(1.08) $4.50 $3.00 $1.30


= $4.80

fixed costs
new unit contribution margin
$468,000

97,500 units
$4.80

Break-even point

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2011 The McGraw-Hill Companies, Inc.


7-27

PROBLEM 7-40 (CONTINUED)


6.

Contribution margin ratio

unit contribution margin


sales price

$25.00 $19.80
$25.00
.208

Old contribution-margin ratio

Let P denote sales price required to maintain a contribution-margin ratio of .208. Then
P is determined as follows:
P $6.00 ($5.00)(1.08) $4.50 $3.00 $1.30
.208
P
P $20.20 .208P
.792P $20.20
P $25.51 (rounded)

Check:

McGraw-Hill/Irwin
7-28

New contributionmargin ratio

$25.51 $6.00 ($5.00)(1.08) $4.50 $3.00 $1.30


$25.51
.208 (rounded)

2011 The McGraw-Hill Companies, Inc.


Solutions Manual

PROBLEM 7-41 (40 MINUTES)


1. CVP graph:

Total revenue
Dollars per year
(in millions)
20
18

Profit
area

Break-even point:
80,000 units or
$8,000,000 of sales

16
14

Total expenses

12
10
8
6
4

Loss
area

Fixed expenses

2
50

McGraw-Hill/Irwin
Managerial Accounting, 9/e Global Edition

100

150

200

Units sold per year


(in thousands)

2011 The McGraw-Hill Companies, Inc.


7-29

PROBLEM 7-41 (CONTINUED)


2.

Break-even point:
contribution margin $12,000,000

.75
sales
$16,000,000
fixed expenses
$6,000,000
Break - even point

contribution - margin ratio


.75
$8,000,000

Contribution - margin ratio

3.

Margin of safety = budgeted sales revenue break-even sales revenue


= $16,000,000 $8,000,000 = $8,000,000
contribution margin (at budgeted sales)
operating income (at budgeted sales)
$12,000,000

2
$6,000,000

4.

Operating leverage factor


(at budgeted sales)

5.

Dollar sales required to


earn target operating
income

fixed expenses target operating income


contribution - margin ratio

$6,000,000 $9,000,000
$20,000,000
.75

6.

Cost structure:
Sales revenue .......................................................
Variable expenses ................................................
Contribution margin.............................................
Fixed expenses ....................................................
Operating income.................................................

McGraw-Hill/Irwin
7-30

Amount
$16,000,000
4,000,000
$12,000,000
6,000,000
$6,000,000

Percent
100.0
25.0
75.0
37.5
37.5

2011 The McGraw-Hill Companies, Inc.


Solutions Manual

PROBLEM 7-42 (35 MINUTES)


1.

(a)

Unit contribution margin

(b)

sales variable costs


units sold
$1,000,000 $700,000
$3 per unit
100,000

Break-even point (in units)

fixed costs
unit contribution margin

$210,000
70,000 units
$3

Contribution-margin ratio

Break-even point (in sales dollars)

2.

Number of units of sales required


to earn target after-tax net income

contribution margin
sales revenue
$1,000,000 $700,000
.3
$1,000,000
fixed costs
contribution-margin ratio
$210,000
$700,000
.3

target after-tax net income


(1 t )
unit contribution margin

fixed costs

$210,000

$90,000
(1 .4)

$3

$360,000
$3

120,000 units
3.

If fixed costs increase by $31,500:

Break-even point (in units)

McGraw-Hill/Irwin
Managerial Accounting, 9/e Global Edition

$210,000 $31,500
80,500 units
$3

2011 The McGraw-Hill Companies, Inc.


7-31

PROBLEM 7-42 (CONTINUED)


4. Profit-volume graph:

Dollars per year


$750,000

$500,000

$250,000

Break-even point:
70,000 units

Loss 25,000
area

50,000

75,000

Profit
area

100,000

Units sold
per year

$(250,000)

$(500,000)

$(750,000)

McGraw-Hill/Irwin
7-32

2011 The McGraw-Hill Companies, Inc.


Solutions Manual

PROBLEM 7-42 (CONTINUED)


5.

Number of units of sales


required to earn target
after-tax net income

target after- tax net income


(1 t )
unit contribution margin

fixed costs

$210,000

$90,000
(1 .5)

$3

$390,000
$3

130,000 units
6.

In the electronic version of the solutions manual, press the CTRL key and click on
the following link: Build a Spreadsheet 07-42.xls

PROBLEM 7-43 (40 MINUTES)


1.

In order to break even, during the first year of operations, 10,220 clients must visit the
law office being considered by Martin Wong and his colleagues, as the following
calculations show.
Fixed expenses:
Advertising ...............................................................................
$ 350,000
Rent (600 $480) .....................................................................
288,000
Property insurance ..................................................................
27,000
Utilities .....................................................................................
37,000
Malpractice insurance .............................................................
160,000
Depreciation ($120,000/4) ........................................................
30,000
Wages and fringe benefits:
Regular wages
($25 + $20 + $15 + $10) 16 hours 360 days .......... $403,200
Overtime wages
(200 $15 1.5) + (200 $10 1.5) ...........................
7,500
Total wages ............................................................ $410,700
Fringe benefits at 40% ....................................................... 164,280
574,980
Total fixed expenses......................................................................
$1,466,980

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2011 The McGraw-Hill Companies, Inc.


7-33

PROBLEM 7-43 (CONTINUED)


Break-even point:
0 = revenue variable cost fixed cost
0 = $30X + ($2,000 .2X .3)* $4X $1,466,980
0 = $30X + $120X $4X $1,466,980
$146X = $1,466,980
X = 10,048 clients (rounded)
*Revenue calculation:
$30X represents the $30 consultation fee per client. ($2,000 .2X .30) represents
the predicted average settlement of $2,000, multiplied by the 20% of the clients
whose judgments are expected to be favorable, multiplied by the 30% of the
judgment that goes to the firm.
2.

Safety margin:
Safety margin = budgeted sales revenue break-even sales revenue
Budgeted (expected) number of clients = 50 360 = 18,000
Break-even number of clients = 10,048 (rounded)
Safety margin = [($30 18,000) + ($2,000 18,000 .20 .30)]
[($30 10,048) + ($2,000 10,048 .20 .30)]
= [$30 + ($2,000 .20 .30)] (18,000 10,048)
= $150 7,852
= $1,192,800

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2011 The McGraw-Hill Companies, Inc.


Solutions Manual

PROBLEM 7-44 (45 MINUTES)


1.

Break-even point in units:

Break-even point

fixed costs
unit contribution margin

Calculation of contribution margins:

Selling price......................................
Variable costs:
Direct material..............................
Direct labor ..................................
Variable overhead ........................
Variable selling cost ....................
Contribution margin per unit
(a)

Computer-Assisted
Manufacturing System
$30.00
$5.00
6.00
3.00
2.00

16.00
$14.00

Labor-Intensive
Production System
$30.00
$5.60
7.20
4.80
2.00

19.60
$10.40

Computer-assisted manufacturing system:

$2,440,000 $500,000
$14
$2,940,000

$14
210,000 units

Break-even point in units

(b)

Labor-intensive production system:

$1,320,000 $500,000
$10.40
$1,820,000

$10.40
175,000 units

Break-even point in units

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7-35

PROBLEM 7-44 (CONTINUED)


2.

Celestial Products, Inc. would be indifferent between the two manufacturing


methods at the volume (X) where total costs are equal.
$16X + $2,940,000 = $19.60X + $1,820,000
$3.60X = $1,120,000
X = 311,111 units (rounded)

3.

Operating leverage is the extent to which a firm's operations employ fixed operating
costs. The greater the proportion of fixed costs used to produce a product, the
greater the degree of operating leverage. Thus, the computer-assisted
manufacturing method utilizes a greater degree of operating leverage.
The greater the degree of operating leverage, the greater the change in
operating income (loss) relative to a small fluctuation in sales volume. Thus, there
is a higher degree of variability in operating income if operating leverage is high.

4.

Management should employ the computer-assisted manufacturing method if annual


sales are expected to exceed 311,111 units and the labor-intensive manufacturing
method if annual sales are not expected to exceed 311,111 units.

5.

Celestial Products management should consider many other business factors


other than operating leverage before selecting a manufacturing method. Among
these are:

Variability or uncertainty with respect to demand quantity and selling price.


The ability to produce and market the new product quickly.
The ability to discontinue production and marketing of the new product while
incurring the least amount of loss.

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2011 The McGraw-Hill Companies, Inc.


Solutions Manual

PROBLEM 7-45 (45 MINUTES)


1.

Break-even sales volume for each model:

(a)

(b)

(c)

Break-even volume

annualrental cost
unit contribution margin

Break - even volume

$8,000
25,000 liters
$1.75 $1.43

Break - even volume

$11,000
27,500 liters
$1.75 $1.35

Break - even volume

$20,000
40,816 liters (rounded)
$1.75 $1.26

Economy model:

Regular model:

Super model:

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7-37

PROBLEM 7-45 (CONTINUED)


2. Profit-volume graph:

Dollars per year (in


thousands)

Profit

$20

$10

Break-even point:
40,816 liters
10

20

30

40

Profit
area

50

Liters sold
per year
(in thousands)

Loss

Loss
area
($10)

($20)

McGraw-Hill/Irwin
7-38

Fixed rental cost: $20,000 per year

2011 The McGraw-Hill Companies, Inc.


Solutions Manual

PROBLEM 7-45 (CONTINUED)


3.

The sales price per liter is the same regardless of the type of machine selected.
Therefore, the same profit (or loss) will be achieved with the Economy and Regular
models at the sales volume, X, where the total costs are the same.
Model
Economy ....................................................
Regular ......................................................

Variable Cost
per Liter
$1.43
1.35

Total
Fixed Cost
$ 8,000
11,000

This reasoning leads to the following equation:

8,000 + 1.43X = 11,000 + 1.35X

Rearranging terms yields the following:

(1.43 1.35)X = 11,000 8,000


.08X = 3,000
X = 3,000/.08
X = 37,500

Or, stated slightly differently:


Volume at which both machines
produce the same profit

fixed cost differential


variable cost differential
$3,000

$.08
37,500 liters

Check: the total cost is the same with either model if 37,500 liters are sold.
Economy
Variable cost:
Economy, 37,500 $1.43 ..........................
Regular, 37,500 $1.35 .............................
Fixed cost:
Economy, $8,000 .......................................
Regular, $11,000 ........................................
Total cost .........................................................

Regular

$53,625
$50,625
8,000
$61,625

11,000
$61,625

Since the sales price for popcorn does not depend on the popper model, the sales
revenue will be the same under either alternative.

McGraw-Hill/Irwin
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2011 The McGraw-Hill Companies, Inc.


7-39

PROBLEM 7-46 (35 MINUTES)


1.

Unit contribution margin

$625,000 $375,000
25,000 units

$10 per unit

2.

3.

Break-even point (in units)

fixed costs
unit contribution margin

$150,000
15,000 units
$10

Number of sales units required


to earn target operating income

New break - even point (in units)

fixed costs target operating income


unit contribution margin

$150,000 $140,000
29,000 units
$10

new fixed costs


new unit contribution margin
$150,000 ($24,000/6) *
19,250 units
$10 $2

*Annual straight-line depreciation on new machine


$2.00

4.

= $4.50 $2.50 increase in the unit cost of the new part

Number of sales units required


to earn target operating
income, given
manufacturing changes

new fixed costs target net profit


new unit contribution margin

$154,000 $100,000 *
$8

31,750 units

*Last year's profit: ($25)(25,000) $525,000 = $100,000

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Solutions Manual

PROBLEM 7-46 (CONTINUED)

unit contribution margin


sales price
$10
Old contribution-margin ratio
.40
$25*
Contribution-margin ratio

5.

*Given in problem.
Let P denote the price required to cover increased direct-material cost and maintain
the same contribution margin ratio:

P $15* $2
.40
P
P $17 .40P
.60P $17
P $28.33 (rounded)
*Old unit variable cost = $15 = $375,000 25,000 units
Increase

in direct-material cost = $2

Check:

$28.33 $15 $2
$28.33
.40 (rounded)

New contribution-margin ratio

McGraw-Hill/Irwin
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2011 The McGraw-Hill Companies, Inc.


7-41

PROBLEM 7-47 (40 MINUTES)


1.

Memorandum

Date:

Today

To:

Vice President for Manufacturing, Halong Game Company

From:

Controller

Subject:

Activity-Based Costing

The $150,000 cost that has been characterized as fixed is fixed with respect to sales volume.
This cost will not increase with increases in sales volume. However, as the activity-based
costing analysis demonstrates, these costs are not fixed with respect to other important
cost drivers. This is the difference between a traditional costing system and an ABC system.
The latter recognizes that costs vary with respect to a variety of cost drivers, not just sales
volume.
2.

New break-even point if automated manufacturing equipment is installed:


Sales price .....................................................................................................
Costs that are variable (with respect to sales volume):
Unit variable cost (.8 $375,000 25,000) ...........................................
Unit contribution margin ..............................................................................
Costs that are fixed (with respect to sales volume):
Setup (300 setups at $40 per setup) .............................................
Engineering (800 hours at $28 per hour) .....................................
Inspection (100 inspections at $45 per inspection) ....................
General factory overhead ..............................................................
Total ..........................................................................................
Fixed selling and administrative costs ..............................................
Total costs that are fixed (with respect to sales volume) ...........
Break - even point (in units)

$26
12
$14
$ 12,000
22,400
4,500
176,100
$215,000
30,000
$245,000

fixed costs
unit contribution margin
$245,000
$14

17,500 units

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Solutions Manual

PROBLEM 7-47 (CONTINUED)


3.

Sales (in units) required to show operating income of $140,000:


fixed cost target operating income
Number of sales units required

to earn target operating income


unit contribution margin
$245,000 $140,000
$14
27,515 units (rounded)

4.

If management adopts the new manufacturing technology:


(a)

Its break-even point will be higher (17,500 units instead of 15,000 units).

(b)

The number of sales units required to show operating income of $140,000 will be
lower (27,515 units instead of 29,000 units).

(c)

These results are typical of situations where firms adopt advanced manufacturing
equipment and practices. The break-even point increases because of the
increased fixed costs due to the large investment in equipment. However, at
higher levels of sales after fixed costs have been covered, the larger unit
contribution margin ($14 instead of $10) earns a profit at a faster rate. This results
in the firm needing to sell fewer units to reach a given target profit level.

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7-43

PROBLEM 7-47 (CONTINUED)


5.

The controller should include the break-even analysis in the report. The Board of
Directors needs a complete picture of the financial implications of the proposed
equipment acquisition. The break-even point is a relevant piece of information. The
controller should accompany the break-even analysis with an explanation as to
why the break-even point will increase. It would also be appropriate for the
controller to point out in the report that the advanced manufacturing equipment
would require fewer sales units at higher volumes in order to achieve a given
target profit, as in requirement (3) of this problem.
To withhold the break-even analysis from the controller's report would be a
violation of the following ethical standards:
(a)

Competence: Provide decision support information and recommendations that are


accurate, clear, concise, and timely.

(b)

Integrity: Refrain from engaging in any conduct that would prejudice carrying out
duties ethically.

(c)

Credibility: Communicate information fairly and objectively. Disclose all relevant


information that could reasonably be expected to influence an intended user's
understanding of the reports, analyses, and recommendations.

McGraw-Hill/Irwin
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Solutions Manual

PROBLEM 7-48 (25 MINUTES)


1.

Closing of downtown store:


Loss of contribution margin at Downtown Store .......................................... $(36,000)
Savings of fixed cost at Downtown Store (75%) ...........................................
30,000
Loss of contribution margin at Mall Store (10%) ...........................................
(4,800)
Total decrease in operating income ............................................................... $(10,800)

2.

Promotional campaign:
Increase in contribution margin (10%) ...........................................................
Increase in monthly promotional expenses ($60,000/12) .............................
Decrease in operating income ........................................................................

3.

$ 3,600
(5,000)
$(1,400)

Elimination of items sold at their variable cost:


We can restate the November 20x1 data for the Downtown Store as follows:

Sales ..................................................................................
Less: variable expenses ...................................................
Contribution margin..........................................................

Downtown Store
Items Sold at
Their
Variable Cost Other Items
$60,000*
$60,000*
60,000
24,000
$
-0$ 36,000

If the items sold at their variable cost are eliminated, we have:


Decrease in contribution margin on other items (20%) ..............................
Decrease in fixed expenses (15%) ................................................................
Decrease in operating income ......................................................................

$(7,200)
6,000
$(1,200)

*$60,000 is one half of the Downtown Store's dollar sales for November 20x1.
4. In the electronic version of the solutions manual, press the CTRL key and click on the
following link: Build a Spreadsheet 07-48.xls

McGraw-Hill/Irwin
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7-45

PROBLEM 7-49 (45 MINUTES)


1.
CHENNAI TOOL COMPANY
BUDGETED INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 20X2
Weeders
Unit selling price ...............................
$28
Variable manufacturing cost ...........
$13
Variable selling cost .........................
5
Total variable cost ............................
$18
Contribution margin per unit ...........
$10
Unit sales .......................................... 50,000
Total contribution margin ............ $500,000

Hedge
Clippers
$36
$12
4
$16
$20
50,000
$1,000,000

Leaf Blowers Total


$48
$25
6
$31
$17
100,000
$1,700,000 $3,200,000

Fixed manufacturing overhead........


Fixed selling and
administrative costs ....................
Total fixed costs ...........................
Income before taxes .........................
Income taxes (40%) ..........................
Budgeted net income .......................

$2,160,000
600,000
$2,760,000
$440,000
176,000
$ 264,000

2.
(a)
Unit
Contribution
Weeders ......................................................
$10
Hedge Clippers ...........................................
20
Leaf Blowers ...............................................
17
Weighted-average unit
contribution margin ..............................

(b)
Sales
Proportion
.25
.25
.50

(a) (b)
$ 2.50
5.00
8.50
$16.00

total fixed costs


weighted - average unit contribution margin
$2,760,000

172,500 units
$16

Total unit sales to break even

McGraw-Hill/Irwin
7-46

2011 The McGraw-Hill Companies, Inc.


Solutions Manual

PROBLEM 7-49 (CONTINUED)


Sales proportions:

Weeders ........................................................
Hedge Clippers .............................................
Leaf Blowers .................................................
Total ...............................................................

Sales
Proportion
.25
.25
.50

Total Unit Product Line


Sales
Sales
172,500
43,125
172,500
43,125
172,500
86,250
172,500

3.
(a)
Unit
Contribution
Weeders ................................................................... $10
Hedge Clippers* ...................................................... 19
Leaf Blowers .......................................................... 12
Weighted-average unit contribution margin .........

(b)
Sales
Proportion
.20
.20
.60

(a) (b)
$ 2.00
3.80
7.20
$13.00

*Variable selling cost increases. Thus, the unit contribution decreases to


$19 [$36 ($12 + $4 + $1)].
The

variable manufacturing cost increases 20 percent. Thus, the unit contribution


decreases to $12 [$48 (1.2 $25) $6].

total fixed costs


weighted - average unit contribution margin
$2,760,000

212,308 units (rounded)


$13

Total unit sales to break even

Sales proportions:
Sales
Proportions
Weeders .............................................................. .20
Hedge Clippers ................................................... .20
Leaf Blowers ....................................................... .60
Total .....................................................................

McGraw-Hill/Irwin
Managerial Accounting, 9/e Global Edition

Total Unit
Sales
212,308
212,308
212,308

Product Line
Sales
53,077
53,077
106,154
212,308

2011 The McGraw-Hill Companies, Inc.


7-47

PROBLEM 7-50 (45 MINUTES)


1.

Unit contribution margin

$405,000
$225 per ton
1,800

Break-even volume in tons

fixed costs
unit contribution margin

2.

$247,500
1,100 tons
$225

Projected operating income for sales of 2,100 tons:


Projected contribution margin (2,100 $225) .......................................
Projected fixed costs ..............................................................................
Projected operating income ...................................................................

3.

$472,500
247,500
$225,000

Projected operating income including German order:


Variable cost per ton = $495,000/1,800 = $275 per ton
Sales price per ton for regular orders = $900,000/1,800 = $500 per ton

Sales in tons .....................................................................


Contribution margin per ton:
German order ($450 $275) ......................................
Regular sales ($500 $275) .......................................
Total contribution margin ................................................

German
Order
1,500

$175

$262,500

Contribution margin on German order......................................................


Contribution margin on regular sales .......................................................
Total contribution margin ..........................................................................
Fixed costs ..................................................................................................
Operating income .......................................................................................

McGraw-Hill/Irwin
7-48

Regular
Sales
1,500
$225
$337,500
$262,500
337,500
$600,000
247,500
$352,500

2011 The McGraw-Hill Companies, Inc.


Solutions Manual

PROBLEM 7-50 (CONTINUED)


4.

New sales territory:


To maintain its current operating income, Ohio Limestone Company just needs to
break even on sales in the new territory.

Break-even point in tons

5.

fixed costsin new territory


unit contribution margin on sales in new territory
$61,500
307.5 tons
$225 $25

Automated production process:

Break-even point in tons

$247,500 $58,500
$225 $25
$306,000
1,224 tons
$250

Break-even point in sales dollars 1,224 tons $500 per ton


$612,000
6.

Changes in selling price and unit variable cost:


New unit contribution margin ($500)(90%) ($275 $40)
$135
$135
($500)(90%)
.30

New contribution margin ratio

fixed costs target operating income


contribution margin ratio
$247,500 $94,500

.30
$1,140,000

Dollar sales required to earn targe t operating income

McGraw-Hill/Irwin
Managerial Accounting, 9/e Global Edition

2011 The McGraw-Hill Companies, Inc.


7-49

PROBLEM 7-51 (35 MINUTES)


$162.50 $117.00
.28
$162.50

1.

Contribution margin ratio

2.

Number of units of sales required


to earn target after-tax net income

target after - tax net income


(1 t)
unit contribution margin

fixed expenses

$44,160
(1 .40) $614,250
X

$162.50 $117.00
$45.50
$540,650

X 13,500 units

3.

Break-even point (in units) for the


mountaineering model

$693,000
11,000 units
$180.00 $117.00

Let Y denote the variable cost of the touring model such that the break-even point
for the touring model is 11,000 units.
Then we have:
$540,650
$162.50 Y
(11,000) ($162.50 Y ) $540,650
$1,787,500 11,000Y $540,650
11,000Y $1,246,850
Y $113.35
11,000

Thus, the variable cost per unit would have to decrease by $3.65 ($117.00 $113.35).

McGraw-Hill/Irwin
7-50

2011 The McGraw-Hill Companies, Inc.


Solutions Manual

PROBLEM 7-51 (CONTINUED)


4.

5.

$540,650 110%
$162.50 ($117.00)(90%)
$594,715

$57.20
10,397 units (rounded)

New break - even point

Weighted-average unit
contribution margin
Break-even point

(50% $63.00) (50% $45.50)


$54.25
fixed costs

weighted - average unit contribution margin


$616,825

11,370 units (rounded; or 5,685 of each type)


$54.25

PROBLEM 7-52 (45 MINUTES)


1.

SUMMARY OF EXPENSES

Manufacturing ....................................................................
Selling and administrative ................................................
Interest ...............................................................................
Costs from budgeted income statement .....................
If the company employs its own sales force:
Additional sales force costs .........................................
Reduced commissions [(.15 .10) $16,000].............
Costs with own sales force ...............................................
If the company sells through agents:
Deduct cost of sales force ............................................
Increased commissions [(.225 .10) $16,000] .........
Costs with agents paid increased commissions ............

McGraw-Hill/Irwin
Managerial Accounting, 9/e Global Edition

Expenses per Year


(in thousands)
Variable
Fixed
$ 7,200
$2,340
2,400
1,920
540
$ 9,600
$4,800
2,400
(800)
$ 8,800

$7,200
(2,400)

2,000
$ 10,800

$4,800

2011 The McGraw-Hill Companies, Inc.


7-51

PROBLEM 7-52 (CONTINUED)

totalfixed expenses
contribution margin ratio
total variable expenses
Contribution-margin ratio 1
sales revenue

Break-even sales dollars

(a)

$9,600,000
$16,000,000
1 .60

Contribution margin ratio 1


.40

$4,800,000
.40
$12,000,000

Break-even sales dollars

(b)

$8,800,000
$16,000,000
1 .55

Contribution margin ratio 1

.45
$7,200,000
.45
$16,000,000

Break-even sales dollars

2.

Requiredsales dollars

totalfixed costs target income beforeincome taxes


contribution margin ratio

$10,800
$16,000
1 .675
.325

Contribution margin ratio 1

$4,800,000 $1,600,000
.325
$6,400,000

.325
$19,692,308

Required sales dollars to break even

McGraw-Hill/Irwin
7-52

2011 The McGraw-Hill Companies, Inc.


Solutions Manual

PROBLEM 7-52 (CONTINUED)


3.

The volume in sales dollars (X) that would result in equal net income is the volume
of sales dollars where total expenses are equal.
Total expenses with agents paid
increased commission

= total expenses with own sales force

$10,800,000
$8,800,000
X $4,800,000
X $7,200,000
$16,000,000
$16,000,000
.675 X $4,800,000 .55 X $7,200,000
.125 X $2,400,000
X $19,200,000
Therefore, at a sales volume of $19,200,000, the company will earn equal before-tax
income under either alternative. Since before-tax income is the same, so is after-tax
net income.

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2011 The McGraw-Hill Companies, Inc.


7-53

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