Assignment Material

NOTE: To underscore the basic CVP relationships, the assignment material ignores income taxes unless stated otherwise.

Questions

  1. 3-1. Define cost–volume–profit analysis.
  2. 3-2. Describe the assumptions underlying CVP analysis.
  3. 3-3. Distinguish between operating income and net income.
  4. 3-4. Define contribution margin, contribution margin per unit, and contribution margin percentage.
  5. 3-5. Describe three methods that managers can use to express CVP relationships.
  6. 3-6. Why is it more accurate to describe the subject matter of this chapter as CVP analysis rather than as breakeven analysis?
  7. 3-7. “CVP analysis is both simple and simplistic. If you want realistic analysis to underpin your decisions, look beyond CVP analysis.” Do you agree? Explain.
  8. 3-8. How does an increase in the income tax rate affect the breakeven point?
  9. 3-9. Describe sensitivity analysis. How has the advent of the electronic spreadsheet affected the use of sensitivity analysis?
  10. 3-10. Give an example of how a manager can decrease variable costs while increasing fixed costs.
  11. 3-11. Give an example of how a manager can increase variable costs while decreasing fixed costs.
  12. 3-12. What is operating leverage? How is the degree of operating leverage helpful to managers?
  13. 3-13. “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?
  14. 3-14. How can a company with multiple products compute its breakeven point?
  15. 3-15. “In CVP analysis, gross margin is a less-useful concept than contribution margin.” Do you agree? Explain briefly.

Multiple-Choice Questions

In partnership with Becker professional education
  1. 3-16. Jack’s Jax has total fixed costs of $25,000. If the company’s contribution margin is 60%, the income tax rate is 25% and the selling price of a box of Jax is $20, how many boxes of Jax would the company need to sell to produce a net income of $15,000?
    1. a. 5,625
    2. b. 4,445
    3. c. 3,750
    4. d. 3,333
  2. 3-17. During the current year, XYZ Company increased its variable SG&A expenses while keeping fixed SG&A expenses the same. As a result, XYZ’s
    1. a. Contribution margin and gross margin will be lower.
    2. b. Contribution margin will be higher, while its gross margin will remain the same.
    3. c. Operating income will be the same under both the financial accounting income statement and contribution income statement.
    4. d. Inventory amounts booked under the financial accounting income statement will be lower than under the contribution income statement.
  3. 3-18. Under the contribution income statement, a company’s contribution margin will be
    1. a. Higher if fixed SG&A costs decrease.
    2. b. Higher if variable SG&A costs increase.
    3. c. Lower if fixed manufacturing overhead costs decrease.
    4. d. Lower if variable manufacturing overhead costs increase.
  4. 3-19. A company needs to sell 10,000 units of its only product in order to break even. Fixed costs are $110,000, and the per unit selling price and variable costs are $20 and $9, respectively. If total sales are $220,000, the company’s margin of safety will be equal to
    1. a. $0
    2. b. $20,000
    3. c. $110,000
    4. d. $200,000
  5. 3-20. Once a company exceeds its breakeven level, operating income can be calculated by multiplying
    1. a. The sales price by unit sales in excess of breakeven units.
    2. b. Unit sales by the difference between the sales price and fixed cost per unit.
    3. c. The contribution margin ratio by the difference between unit sales and breakeven sales.
    4. d. The contribution margin per unit by the difference between unit sales and breakeven sales.

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Exercises

  1. 3-21. CVP COMPUTATIONS. Fill in the blanks for each of the following independent cases.
The table shows CVP computations for the student to complete.

The table depicts CVP computations (revenues, variable costs, fixed costs, total costs, operating income, and contribution margin percentage) for four cases, and the student is to complete the missing amounts (noted as “Blank” here). The details of the table are as follows:

  1. Case a

    • Revenues: Blank
    • Variable Costs: 600 dollars
    • Fixed Costs: Blank
    • Total Costs: 800 dollars
    • Operating Income: 1,600 dollars
    • Contribution Margin Percentage: Blank

  2. Case b

    • Revenues: 2,500 dollars
    • Variable Costs: Blank
    • Fixed Costs: 200 dollars
    • Total Costs: Blank
    • Operating Income: 900 dollars
    • Contribution Margin Percentage: Blank

  3. Case c

    • Revenues: 500 dollars
    • Variable Costs: 300 dollars
    • Fixed Costs: Blank
    • Total Costs: 500 dollars
    • Operating Income: Blank
    • Contribution Margin Percentage: Blank

  4. Case d

    • Revenues: 1,200 dollars
    • Variable Costs: Blank
    • Fixed Costs: 200 dollars
    • Total Costs: Blank
    • Operating Income: Blank
    • Contribution Margin Percentage: 25 percent
  1. 3-22. CVP COMPUTATIONS. Davidson Manufacturing sold 435,000 units of its product for $74 per unit in 2020. Variable cost per unit is $62, and total fixed costs are $1,940,000.
    1. Required
    2. 1. Calculate (a) contribution margin and (b) operating income.
    3. 2. Davidson’s current manufacturing process is labor intensive. Kate Schmidt, Davidson’s production manager, has proposed investing in state-of-the-art manufacturing equipment, which will increase the annual fixed costs to $5,655,000. The variable costs are expected to decrease to $54 per unit. Davidson expects to maintain the same sales volume and selling price next year. How would acceptance of Schmidt’s proposal affect your answers to (a) and (b) in requirement 1?
    4. 3. Should Davidson’s executives accept Schmidt’s proposal? Explain.
  2. 3-23. CVP ANALYSIS, CHANGING REVENUES AND COSTS. Sunset Travel Agency specializes in flights between Toronto and Jamaica. It books passengers on Hamilton Air. Sunset’s fixed costs are $23,500 per month. Hamilton Air charges passengers $1,500 per round-trip ticket.
  3. Calculate the number of tickets Sunset must sell each month to (a) break even and (b) make a target operating income of $10,000 per month in each of the following independent cases.
    1. Required
    2. 1. Sunset’s variable costs are $43 per ticket. Hamilton Air pays Sunset 6% commission on ticket price.
    3. 2. Sunset’s variable costs are $40 per ticket. Hamilton Air pays Sunset 6% commission on ticket price.
    4. 3. Sunset’s variable costs are $40 per ticket. Hamilton Air pays $60 fixed commission per ticket to Sunset. Comment on the results.
    5. 4. Sunset’s variable costs are $40 per ticket. It receives $60 commission per ticket from Hamilton Air. It charges its customers a delivery fee of $5 per ticket. Comment on the results.
  4. 3-24. CVP EXERCISES. The Deli-Sub Shop owns and operates six stores in and around Minneapolis. You are given the following corporate budget data for next year:
Corporate budget data for Deli-Sub Shop

Revenues: 11,000,000 dollars

Fixed costs: 3,000,000 dollars

Variable costs: 7,500,000 dollars

  1. Variable costs change based on the number of subs sold.
  2. Compute the budgeted operating income for each of the following deviations from the original budget data. (Consider each case independently.)
    1. Required
    2. 1. A 10% increase in contribution margin, holding revenues constant
    3. 2. A 10% decrease in contribution margin, holding revenues constant
    4. 3. A 5% increase in fixed costs
    5. 4. A 5% decrease in fixed costs
    6. 5. A 5% increase in units sold
    7. 6. A 5% decrease in units sold
    8. 7. A 10% increase in fixed costs and a 10% increase in units sold
    9. 8. A 5% increase in fixed costs and a 5% decrease in variable costs
    10. 9. Which of these alternatives yields the highest budgeted operating income? Explain why this is the case.
  3. 3-25. CVP EXERCISES. The Doral Company manufactures and sells pens. Currently, 5,000,000 units are sold per year at $0.50 per unit. Fixed costs are $900,000 per year. Variable costs are $0.30 per unit. (Consider each case separately.)
    1. Required
    2. 1. a. What is the current annual operating income?
    3. b. What is the current breakeven point in revenues?
  4. Compute the new operating income for each of the following changes:
    1. 2. A $0.04 per unit increase in variable costs
    2. 3. A 10% increase in fixed costs and a 10% increase in units sold
    3. 4. A 20% decrease in fixed costs, a 20% decrease in selling price, a 10% decrease in variable cost per unit, and a 40% increase in units sold
  5. Compute the new breakeven point in units for each of the following changes:
    1. 5. A 10% increase in fixed costs
    2. 6. A 10% increase in selling price and a $20,000 increase in fixed costs
  6. 3-26. CVP RELATIONSHIPS. The McNamara Company has a maximum production capacity of 20,000 units per year. For that capacity level, fixed costs are $280,000 per year. Variable costs per unit are $30.
  7. In the coming year, the company has orders for 24,000 units at $50. The company wants to make a minimum overall operating income of $148,000 on these 24,000 units.
  8. Required
  9. What maximum unit purchase price would McNamara Company be willing to pay to a subcontractor for the additional 4,000 units it cannot manufacture itself to earn an operating income of $148,000.
  10. 3-27. CVP ANALYSIS, INCOME TAXES. The Express Meal has two restaurants that are open 24 hours a day. Fixed costs for the two restaurants together total $400,000 per year. Service varies from a cup of coffee to full meals. The average sales check per customer is $8.50. The average cost of food and other variable costs for each customer is $3.50. The income tax rate is 30%. Target net income is $140,000.
    1. Required
    2. 1. Compute the revenues needed to earn the target net income.
    3. 2. How many customers are needed to break even? To earn net income of $140,000?
    4. 3. Compute net income if the number of customers is 150,000.
  11. 3-28. CVP ANALYSIS, SENSITIVITY ANALYSIS. Right Fit Jeans Co. sells blue jeans wholesale to major retailers across the country. Each pair of jeans has a selling price of $40 with $30 in variable costs of goods sold. The company has fixed manufacturing costs of $1,050,000 and fixed marketing costs of $150,000. Sales commissions are paid to the wholesale sales reps at 10% of revenues. The company has an income tax rate of 20%.
    1. Required
    2. 1. How many jeans must Right Fit sell in order to break even?
    3. 2. How many jeans must the company sell in order to reach
      1. a. A target operating income of $300,000?
      2. b. A net income of $300,000?
    4. 3. How many jeans would Right Fit have to sell to earn the net income in requirement 2b if (Consider each requirement independently.)
      1. a. The contribution margin per unit increases by 20%.
      2. b. The selling price is increased to $45.
      3. c. The company outsources manufacturing to an overseas company, increasing variable costs per unit by $1.00 and saving 60% of fixed manufacturing costs.
  12. 3-29. CVP ANALYSIS, MARGIN OF SAFETY. Suppose Morrison Corp.’s breakeven point is revenues of $1,100,000. Fixed costs are $660,000.
    1. Required
    2. 1. Compute the contribution margin percentage.
    3. 2. Compute the selling price if variable costs are $16 per unit.
    4. 3. Suppose 75,000 units are sold. Compute the margin of safety in units and dollars.
    5. 4. What does this tell you about the risk of Morrison making a loss? What are the most likely reasons for this risk to increase?
  13. 3-30. CHOOSING MOST PROFITABLE PRODUCTION VOLUME. Answer the following questions.
    1. 1. Blanchard Company manufactures and sells dresses at a variable cost of $30 each and a fixed cost of x. It can sell 6,000 dresses at a selling price of $50 to earn an operating income of $20,000 or it can sell 3,500 dresses at a selling price of $60 and another 2,000 dresses at a selling price of $40. Which alternative should Blanchard choose?
    2. 2. Canta Corporation manufactures and sells a special kind of ball bearing. Its cost structure depends on the number of bearings it produces. Its fixed costs and variable manufacturing cost per unit for different ranges of production are described in the following table:
Production Range in UnitsFixed CostsVariable Manufacturing Cost per Unit
1–3,000$250,000$75 
3,001–6000$350,000$50
6,001–10,000$750,000$25
  1. Canta’s sales director believes the company can sell 2,500 units at a selling price of $300; or 5,000 units at a price of $200; or 8,000 units at a price of $175. If it chose to sell 8,000 units, however, it would incur additional advertising costs of $50,000 and variable selling costs of $5 per unit.
  2. Required
  3. Should Canta Corporation plan to produce and sell (a) 2,500 units (b) 5,000 units or (c) 8,000 units?
  4. 3-31. OPERATING LEVERAGE. Cover Rugs is holding a 2-week carpet sale at Josh’s Club, a local warehouse store. Cover Rugs plans to sell carpets for $950 each. The company will purchase the carpets from a local distributor for $760 each, with the privilege of returning any unsold units for a full refund. Josh’s Club has offered Cover Rugs two payment alternatives for the use of space.
    1. • Option 1: A fixed payment of $7,410 for the sale period
    2. • Option 2: 10% of total revenues earned during the sale period
  5. Assume Cover Rugs will incur no other costs.
    1. Required
    2. 1. Calculate the breakeven point in units for (a) Option 1 and (b) Option 2.
    3. 2. At what level of revenues will Cover Rugs earn the same operating income under either option?
      1. a. For what range of unit sales will Cover Rugs prefer Option 1?
      2. b. For what range of unit sales will Cover Rugs prefer Option 2?
    4. 3. Calculate the degree of operating leverage at sales of 65 units for the two rental options.
    5. 4. Briefly explain and interpret your answer to requirement 3.
  6. 3-32. CVP ANALYSIS, INTERNATIONAL COST STRUCTURE DIFFERENCES. Rugs-R-Us, Inc., is considering three possible countries for the sole manufacturing site of its newest area rug: Brazil, Italy, and France. All area rugs are to be sold to retail outlets in the United States for $250 per unit. These retail outlets add their own markup when selling to final customers. Fixed costs and variable cost per unit (area rug) differ in the three countries.
CountrySales Price to Retail OutletsAnnual Fixed CostsVariable Manufacturing Cost per Area RugVariable Marketing & Distribution Cost per Area Rug
Brazil$250.00$7,500,000$45.00$10.00
Italy 250.00 5,000,000 65.00 15.00
France 250.00 9,000,000 55.00 20.00
    1. Required
    2. 1. Compute the breakeven point for Rugs-R-Us, Inc., in each country in (a) units sold and (b) revenues.
    3. 2. If Rugs-R-Us, Inc., plans to produce and sell 80,000 rugs in 2020, what is the budgeted operating income for each of the three manufacturing locations? Comment on the results.
  2. 3-33. SALES MIX, NEW AND UPGRADE CUSTOMERS. Chartz 1-2-3 is a top-selling electronic spreadsheet product. Chartz is about to release version 5.0. It divides its customers into two groups: new customers and upgrade customers (those who previously purchased Chartz 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:
A table shows differences in prices and costs for new and upgrade customers of Chartz 1-2-3.

The table depicts selling price, variable costs (manufacturing and marketing), and contribution margin for new customers and upgrade customers. The details of the table are as follows:

  1. Selling price

    • New customers: 195 dollars
    • Upgrade customers: 115 dollars

  2. Variable costs

    • New customers: Manufacturing, 15 dollars plus Marketing, 50 dollars for 65 dollars total
    • Upgrade customers: Manufacturing, 15 dollars plus Marketing, 20 dollars for 35 dollars total

  3. Contribution margin

    • New customers: 130 dollars
    • Upgrade customers: 80 dollars
  1. The fixed costs of Chartz 1-2-3 5.0 are $16,500,000. The planned sales mix in units is 60% new customers and 40% upgrade customers.
    1. Required
    2. 1. What is the Chartz 1-2-3 5.0 breakeven point in units, assuming that the planned 60%/40% sales mix is attained?
    3. 2. If the sales mix is attained, what is the operating income when 170,000 total units are sold?
    4. 3. Show how the breakeven point in units changes with the following customer mixes:
      1. a. New 40% and upgrade 60%
      2. b. New 80% and upgrade 20%
      3. c. Comment on the results.
  2. 3-34. SALES MIX, THREE PRODUCTS. The Kenosha Company has three product lines of beer mugs—A, B, and C—with contribution margins of $5, $4, and $3, respectively. The president foresees sales of 175,000 units in the coming period, consisting of 25,000 units of A, 100,000 units of B, and 50,000 units of C. The company’s fixed costs for the period are $351,000.
    1. Required
    2. 1. What is the company’s breakeven point in units, assuming that the given sales mix is maintained?
    3. 2. If the sales mix is maintained, what is the total contribution margin when 175,000 units are sold? What is the operating income?
    4. 3. What would operating income be if the company sold 25,000 units of A, 75,000 units of B, and 75,000 units of C? What is the new breakeven point in units if these relationships persist in the next period?
    5. 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.
  3. 3-35. CONTRIBUTION MARGIN, DECISION MAKING. Welch Men’s Clothing’s revenues and cost data for 2020 are as follows:
Welch Men’s Clothing’s revenues and cost data for 2020

Revenues: 600,000 dollars

Cost of goods sold (all variable costs): 300,000 dollars

Gross margin: 300,000 dollars

Operating costs include the following:

Salaries fixed: 140,000 dollars

Sales commissions (12 percent of sales): 72,000 dollars

Depreciation of equipment and fixtures: 10,000 dollars

Store rent (3,500 dollars per month): 42,000 dollars

Other operating costs: 45,000 dollars

For a total of 309,000 dollars

Operating income: 9,000 dollar loss

  1. Mr. Welch, the owner of the store, is unhappy with the operating results. An analysis of other operating costs reveals that it includes $30,000 variable costs, which vary with sales volume, and $15,000 (fixed) costs.
    1. Required
    2. 1. Compute the contribution margin of Welch Men’s Clothing.
    3. 2. Compute the contribution margin percentage.
    4. 3. Mr. Welch estimates that he can increase units sold, and hence revenues by 25% by incurring additional advertising costs of $8,000. Calculate the impact of the additional advertising costs on operating income.
    5. 4. What other actions can Mr. Welch take to improve operating income?
  2. 3-36. CONTRIBUTION MARGIN, GROSS MARGIN, AND MARGIN OF SAFETY. Bella Beauty manufactures and sells a face cream to small specialty stores in the greater Los Angeles area. It presents the monthly operating income statement shown here to George Sanchez, a potential investor in the business. Help Mr. Sanchez understand Bella Beauty’s cost structure.
    1. Required
    2. 1. Recast the income statement to emphasize contribution margin.
    3. 2. Calculate the contribution margin percentage and breakeven point in units and revenues for June 2020.
    4. 3. What is the margin of safety (in units) for June 2020?
    5. 4. If sales in June were only 9,500 units and Bella Beauty’s tax rate is 30%, calculate its net income.
Screenshot of a spreadsheet shows the operating income statement for June 2020 of a firm named Bella Beauty.

The details of the spreadsheet are as follows:

  1. 3-37. UNCERTAINTY AND EXPECTED COSTS. Kindmart is an international retail store. Kindmart’s managers are considering implementing a new business-to-business (B2B) information system for processing merchandise orders. The current system costs Kindmart $2,000,000 per month and $55 per order. Kindmart has two options, a partially automated B2B and a fully automated B2B system. The partially automated B2B system will have a fixed cost of $6,000,000 per month and a variable cost of $45 per order. The fully automated B2B system has a fixed cost of $14,000,000 per month and a variable cost of $25 per order.
  2. Based on data from the past 2 years, Kindmart has determined the following distribution on monthly orders:
Monthly Number of OrdersProbability
300,000 0.25
500,000 0.45
700,000 0.30
    1. Required
    2. 1. Prepare a table showing the cost of each plan for each quantity of monthly orders.
    3. 2. What is the expected cost of each plan?
    4. 3. In addition to the information system’s costs, what other factors should Kindmart consider before deciding to implement a new B2B system?

Problems

  1. 3-38. CVP ANALYSIS, SERVICE FIRM. Safari Escapes generates average revenue of $6,250 per person on its 5-day package tours to wildlife parks in Kenya. The variable costs per person are as follows:
Variable costs per person for Safari Escapes package tours

Airfare: 1,300 dollars

Hotel accommodations: 2,450 dollars

Meals: 900 dollars

Ground transportation: 100 dollars

Park tickets and other costs: 500 dollars

Total: 5,250 dollars

  1. Annual fixed costs total $590,000.
    1. Required
    2. 1. Calculate the number of package tours that must be sold to break even.
    3. 2. Calculate the revenue needed to earn a target operating income of $92,000.
    4. 3. If fixed costs increase by $29,500, what decrease in variable cost per person must be achieved to maintain the breakeven point calculated in requirement 1?
    5. 4. The general manager at Safari Escapes proposes to increase the price of the package tour to $7,750 to decrease the breakeven point in units. Using information in the original problem, calculate the new breakeven point in units. What factors should the general manager consider before deciding to increase the price of the package tour?
  2. 3-39. CVP, TARGET OPERATING INCOME, SERVICE FIRM. Spotted Turtle provides day care for children Mondays through Fridays. Its monthly variable costs per child are as follows:
Monthly variable costs per child for Spotted Turtle day care

Lunch and snacks: 130 dollars

Educational supplies: 75 dollars

Other supplies (paper products, toiletries, etc.): 35 dollars

Total: 240 dollars

  1. Monthly fixed costs consist of the following:
Monthly fixed costs for Spotted Turtle day care

Rent: 2,100 dollars

Utilities: 400 dollars

Insurance: 250 dollars

Salaries: 1,400 dollars

Miscellaneous: 650 dollars

Total: 4,800 dollars

  1. Spotted Turtle charges each parent $640 per child per month.
    1. Required
    2. 1. Calculate the breakeven point.
    3. 2. Spotted Turtle’s target operating income is $10,800 per month. Compute the number of children who must be enrolled to achieve the target operating income.
    4. 3. Spotted Turtle lost its lease and had to move to another building. Monthly rent for the new building is $3,500. In addition, at the suggestion of parents, Spotted Turtle plans to take children on field trips. Monthly costs of the field trips are $2,500. By how much should Spotted Turtle increase fees per child to meet the target operating income of $10,800 per month, assuming the same number of children as in requirement 2?
  2. 3-40. CVP ANALYSIS, MARGIN OF SAFETY. Dynamic Docs prepares marketing plans for growing businesses. For 2020, budgeted revenues are $3,500,000 based on 700 marketing plans at an average rate per plan of $5,000. The company would like to achieve a margin of safety percentage of at least 25%. The company’s current fixed costs are $1,800,000 and variable costs average $2,000 per marketing plan. (Consider each of the following separately.)
    1. Required
    2. 1. Calculate Dynamic Docs’ breakeven point and margin of safety in units.
    3. 2. Which of the following changes would help Dynamic Docs achieve its desired margin of safety?
      1. a. The average revenue per customer increases to $5,600.
      2. b. The planned number of marketing plans prepared increases by 8%.
      3. c. Dynamic Docs purchases new software that results in a $48,000 increase to fixed costs but reduces variable costs by $300 per marketing plan.
  3. 3-41. CVP ANALYSIS, INCOME TAXES. (CMA, adapted) J.T. Brooks 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. Brooks, 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. Brooks with the following data for the current year, 2020:
2020 data for J.T. Brooks and Company

Variable cost (per bowl):

Direct materials: 3.00 dollars

Direct manufacturing labor: 8.00 dollars

Variable overhead (manufacturing, marketing, distribution, and customer service): 7.50 dollars

Total variable cost per bowl: 18.50 dollars

Fixed costs:

Manufacturing: 20,000 dollars

Marketing, distribution, and customer service: 194,500 dollars

Total fixed costs: 214,500 dollars

Selling price: 35.00 dollars

Expected sales, 22,000 units: 770,000 dollars

Income tax rate: 40 percent

    1. Required
    2. 1. What is the projected net income for 2020?
    3. 2. What is the breakeven point in units for 2020?
    4. 3. Mr. Brooks has set the revenue target for 2021 at a level of $875,000 (or 25,000 bowls). He believes an additional marketing cost of $16,500 for advertising in 2021, with all other costs remaining constant, will be necessary to attain the revenue target. What is the net income for 2021 if the additional $16,500 is spent and the revenue target is met?
    5. 4. What is the breakeven point in revenues for 2021 if the additional $16,500 is spent for advertising?
    6. 5. If the additional $16,500 is spent, what are the required 2021 revenues for 2021 net income to equal 2020 net income?
    7. 6. At a sales level of 25,000 units, what maximum amount can be spent on advertising if a 2021 net income of $108,450 is desired?
  2. 3-42. CVP, SENSITIVITY ANALYSIS. Jan’s Ornaments sells handmade ornaments for $35.00 per ornament. Operating information for 2020 is as follows:
Jan’s Ornaments operating information for 2020

Sales revenue (35 dollars per ornament): 420,000 dollars

Variable cost (20 dollars per ornament): 240,000 dollars

Contribution margin: 180,000 dollars

Fixed costs: 160,000 dollars

Operating income: 20,000 dollars

  1. Jan, the owner of the company, wants to increase operating income over the next year by at least $20,000. To do so, the company is considering the following options:
    1. Required
    2. 1. Spend $25,000 on advertising, which should result in a 15% increase in sales.
    3. 2. Increase selling price to $39 per ornament, which is expected to decrease sales by 10%.
    4. 3. Automate some steps in the manufacturing process, which would increase fixed costs by $30,000 and decrease variable cost to $18.00 per unit. Sales would remain the same.
    5. 4. Increase the selling price to $36 and decrease variable costs to $19. This alternative would result in a 5% decrease in sales.
  2. Evaluate each of the alternatives considered by Jan’s Ornaments separately. Do any of the options meet or exceed Jan’s targeted increase in operating income of $20,000? What should Jan do?
  3. 3-43. CVP ANALYSIS, SHOE STORES. The HighStep Shoe Company operates a chain of shoe stores that sell 10 different styles of inexpensive men’s shoes with identical unit costs and selling prices. A unit is defined as a pair of shoes. Each store has a store manager who is paid a fixed salary. Individual salespeople receive a fixed salary and a sales commission. HighStep is considering opening another store that is expected to have the revenue and cost relationships shown here. (Consider each question independently.)
    1. Required
    2. 1. What is the annual breakeven point in (a) units sold and (b) revenues?
    3. 2. If 8,000 units are sold, what will be the store’s operating income (loss)?
    4. 3. If sales commissions are discontinued and fixed salaries are raised by a total of $15,500, what would be the annual breakeven point in (a) units sold and (b) revenues?
    5. 4. Refer to the original data. If, in addition to his fixed salary, the store manager is paid a commission of $2.00 per unit sold, what would be the annual breakeven point in (a) units sold and (b) revenues?
    6. 5. Refer to the original data. If, in addition to his fixed salary, the store manager is paid a commission of $2.00 per unit in excess of the breakeven point, what would be the store’s operating income if 12,000 units were sold?
Screenshot of a spreadsheet shows the Unit Variable Data for per pair of shoes and annual fixed costs.

The details of the unit variable data and annual fixed costs are as follows:

  1. Unit variable data (per pair of shoes)

    • Selling price: $60.00

    • Cost of shoes: $37.00

    • Sales commission: 3.00

    • Variable cost per unit: $40.00

  2. Annual fixed costs

    • Rent: $30,000

    • Salaries: 100,000

    • Advertising: 40,000

    • Other fixed costs: 10,000

    • Total fixed costs: $180,000

  1. 3-44. CVP ANALYSIS, SHOE STORES (CONTINUATION OF 3-43). Refer to requirement 3 of Problem 3-43. In this problem, assume the role of the owner of HighStep.
    1. Required
    2. 1. As owner, which sales compensation plan would you choose if forecasted annual sales of the new store were at least 10,000 units? What do you think of the motivational aspect of your chosen compensation plan?
    3. 2. Suppose the target operating income is $69,000. 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. 3. You open the new store on January 1, 2020, with the original salary-plus-commission compensation plan in place. Because you expect the cost of the shoes to rise due to inflation, you place a firm bulk order for 11,000 shoes and lock in the $37 price per unit. But toward the end of the year, only 9,500 shoes are sold, and you authorize a markdown of the remaining inventory to $50 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?
  2. 3-45. ALTERNATE COST STRUCTURES, UNCERTAINTY, AND SENSITIVITY ANALYSIS. Corporate Printing Company currently leases its only copy machine for $1,500 a month. The company is considering replacing this leasing agreement with a new contract that is entirely commission based. Under the new agreement, Corporate would pay a commission for its printing at a rate of $20 for every 500 pages printed. The company currently charges $0.20 per page to its customers. The paper used in printing costs the company $0.05 per page and other variable costs, including hourly labor, amount to $0.10 per page.
    1. Required
    2. 1. What is the company’s breakeven point under the current leasing agreement? What is it under the new commission-based agreement?
    3. 2. For what range of sales levels will Corporate prefer (a) the fixed lease agreement and (b) the commission agreement?
    4. 3. Do this question only if you have covered the chapter appendix in your class. Corporate estimates that the company is equally likely to sell 20,000, 30,000, 40,000, 50,000, or 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 Corporate choose?
  3. 3-46. CVP, ALTERNATIVE COST STRUCTURES. Glamour Accessories operates a kiosk at the local mall, selling cell phone covers for $30 each. Glamour Accessories currently pays $1,000 a month to rent the space and pays two full-time employees to each work 160 hours a month at $10 per hour. The store shares a manager with a neighboring kiosk and pays 50% of the manager’s annual salary of $60,000 and benefits of $12,000. The wholesale cost of the cell phone covers to the company is $10.
    1. Required
    2. 1. How many cell phone covers does Glamour Accessories need to sell each month to break even?
    3. 2. If Glamour Accessories wants to earn an operating income of $5,300 per month, how many cell phone covers does the store need to sell?
    4. 3. If the store’s hourly employees agreed to a 15% sales-commission-only pay structure, instead of their hourly pay, how many cell phone covers would Glamour Accessories need to sell to earn an operating income of $5,300?
    5. 4. Assume Glamour Accessories pays its employees hourly under the original pay structure but is able to pay the mall 10% of its monthly revenue instead of monthly rent. At what sales levels would Glamour Accessories prefer to pay a fixed amount of monthly rent, and at what sales levels would it prefer to pay 10% of its monthly revenue as rent?
  4. 3-47. CVP ANALYSIS, INCOME TAXES, SENSITIVITY. (CMA, adapted) Thompson Engine Company manufactures and sells diesel engines for use in small farming equipment. For its 2020 budget, Thompson Engine Company estimates the following:
Thompson Engine Company estimated 2020 budget

Selling price: 7,000 dollars

Variable cost per engine: 2,000 dollars

Annual fixed costs: 5,560,000 dollars

Net income: 900,000 dollars

Income tax rate: 40 percent

  1. The first-quarter income statement, as of March 31, reported that sales were not meeting expectations. During the first quarter, only 300 units had been sold at the current price of $7,000. The income statement showed that variable and fixed costs were as planned, which meant that the 2020 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:
    1. a. Reduce the selling price by 15%. The sales organization forecasts that at this significantly reduced price, 1,400 units can be sold during the remainder of the year. Total fixed costs and variable cost per unit will stay as budgeted.
    2. b. Lower variable cost per unit by $750 through the use of less-expensive direct materials. The selling price will also be reduced by $800, and sales of 1,130 units are expected for the remainder of the year.
    3. c. Reduce fixed costs by 5% and lower the selling price by 25%. Variable cost per unit will be unchanged. Sales of 1,500 units are expected for the remainder of the year.
    4. Required
    5. 1. If no changes are made to the selling price or cost structure, determine the number of units that Thompson Engine Company must sell (a) to break even and (b) to achieve its net income objective.
    6. 2. Determine which alternative Thompson Engine Company should select to achieve its net income objective. Show your calculations.
  2. 3-48. CHOOSING BETWEEN COMPENSATION PLANS, OPERATING LEVERAGE. (CMA, adapted) Zahner Corporation manufactures housewares products that are sold through a network of external sales agents. The agents are paid a commission of 20% of revenues. Zahner is considering replacing the sales agents with its own salespeople, who would be paid a commission of 10% of revenues and total salaries of $3,520,000. The income statement for the year ending December 31, 2020, under the two scenarios is shown here.
    1. Required
    2. 1. Calculate Zahner’s 2020 contribution margin percentage, breakeven revenue, and degree of operating leverage under the two scenarios.
    3. 2. Describe the advantages and disadvantages of each type of sales alternative.
    4. 3. In 2021, Zahner uses its own salespeople, who demand a 15% 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 2020?
Screenshot of a spreadsheet shows the income Statement of Zahner Corporation for the year ended December 2020.

The details of the costs and revenues either by using sales agents or by using own sales force are as follows:

  1. Using Sales Agents

    The details are given in two columns B and C

    • Row 5 shows revenues in column C as 35,200,000 dollars

    • Row 6 shows cost of goods sold

    • Row 7 shows variable in column B as 13,375,000 dollars

    • Row 8 shows fixed in column B as 4,125,000 and in column C as 17,500,000

    • Row 9 shows gross margin in column C as 17,700,000

    • Row 10 shows marketing costs

    • Row 11 shows commissions in column B as 7,040,000 dollars

    • Row 12 shows fixed costs in column B as 4,025,000 and in column C as 11,065,000.

    • Row 13 shows Operating income in column C as 6,635,000 dollars

  2. Using Own Sales Force

    The details are given in two columns D and E

    • Row 5 shows revenues in column E as 35,200,000 dollars

    • Row 6 shows cost of goods sold

    • Row 7 shows variable in column D as 13,375,000 dollars

    • Row 8 shows fixed in column D as 4,125,000 and in column E as 17,500,000

    • Row 9 shows gross margin in column E as 17,700,000

    • Row 10 shows marketing costs

    • Row 11 shows commissions in column D as 3,520,000 dollars

    • Row 12 shows fixed costs in column D as 7,545,000 and in column C as 11,065,000.

    • Row 13 shows Operating income in column C as 6,635,000 dollars

  1. 3-49. SALES MIX, THREE PRODUCTS. The Ronowski Company has three product lines of belts—A, B, and C—with contribution margins of $3, $2, and $1, respectively. The president foresees sales of 200,000 units in the coming period, consisting of 20,000 units of A, 100,000 units of B, and 80,000 units of C. The company’s fixed costs for the period are $255,000.
    1. Required
    2. 1. What is the company’s breakeven point in units, assuming that the given sales mix is maintained?
    3. 2. If the sales mix is maintained, what is the total contribution margin when 200,000 units are sold? What is the operating income?
    4. 3. What would operating income be if 20,000 units of A, 80,000 units of B, and 100,000 units of C were sold? What is the new breakeven point in units if these relationships persist in the next period?
  2. 3-50. MULTIPRODUCT CVP AND DECISION MAKING. Clear Waters produces two types of water filters. One attaches to the faucet and cleans all water that passes through the faucet. The other is a pitcher-cum-filter that only purifies water meant for drinking.
  3. The unit that attaches to the faucet is sold for $72 and has variable costs of $20.
  4. The pitcher-cum-filter sells for $88 and has variable costs of $16.
  5. Clear Waters sells two faucet models for every three pitchers sold. Fixed costs equal $960,000.
    1. Required
    2. 1. What is the breakeven point in unit sales and dollars for each type of filter at the current sales mix?
    3. 2. Clear Waters is considering buying new production equipment. The new equipment will increase fixed cost by $166,400 per year and will decrease the variable cost of the faucet and the pitcher units by $4 and $8, respectively. Assuming the same sales mix, how many of each type of filter does Clear Waters need to sell to break even?
    4. 3. Assuming the same sales mix, at what total sales level would Clear Waters be indifferent between using the old equipment and buying the new production equipment? If total sales are expected to be 23,000 units, should Clear Waters buy the new production equipment?
  6. 3-51. SALES MIX, TWO PRODUCTS. The Stackpole Company retails two products: a standard and a deluxe version of a luggage carrier. The budgeted income statement for next period is as follows:
A table shows the budgeted income statement for the Stackpole Company.

The table depicts the units sold, revenues at 28 dollars and 40 dollars per unit, variable costs at 18 dollars and 30 dollars per unit, contribution margins at 10 dollars and 20 dollars per unit for the standard carrier and deluxe carrier as well as the total units sold, revenues, variable costs, contribution margins, fixed costs, and operating income. The details of the table are as follows:

  1. Units sold

    • Standard carrier: 187,500
    • Deluxe carrier: 62,500
    • Total: 250,000

  2. Revenues at 28 dollars and 50 dollars per unit

    • Standard carrier: 5,250,000 dollars
    • Deluxe carrier: 3,125,000 dollars
    • Total: 8,375,000 dollars

  3. Variable costs at 18 dollars and 30 dollars per unit

    • Standard carrier: 3,375,000 dollars
    • Deluxe carrier: 1,875,000 dollars
    • Total: 5,250,000 dollars

  4. Contribution margins at 10 dollars and 20 dollars per unit

    • Standard carrier: 1,875,000 dollars
    • Deluxe carrier: 1,250,000 dollars
    • Total: 3,125,000 dollars

  5. Fixed costs, total: 2,250,000 dollars

  6. Operating income, total: 875,000 dollars

    1. Required
    2. 1. Compute the breakeven point in units, assuming that the company achieves its planned sales mix.
    3. 2. Compute the breakeven point in units (a) if only standard carriers are sold and (b) if only deluxe carriers are sold.
    4. 3. Suppose 250,000 units are sold but only 50,000 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?
  2. 3-52. GROSS MARGIN AND CONTRIBUTION MARGIN. The Museum of Fine Art is preparing for its annual appreciation dinner for contributing members. Last year, 500 members attended the dinner. Tickets for the dinner were $30 per attendee. The profit report for last year’s dinner follows.
Museum of Fine Art appreciation dinner profit report

Ticket sales: 15,000 dollars

Cost of dinner: 16,000 dollars

Gross margin: 1,000 dollar loss

Invitations and paperwork: 2,500 dollars

Profit (loss): 3,500 dollar loss

  1. This year the dinner committee does not want to lose money on the dinner. To help achieve its goal, the committee analyzed last year’s costs. Of the $16,000 cost of the dinner, $8,500 were fixed costs and $7,500 were variable costs. Of the $2,500 cost of invitations and paperwork, $1,750 were fixed and $750 were variable.
    1. Required
    2. 1. Prepare last year’s profit report using the contribution margin format.
    3. 2. The committee is considering expanding this year’s dinner invitation list to include volunteer members (in addition to contributing members). If the committee expands the dinner invitation list, it expects attendance to double. Calculate the effect this will have on the profitability of the dinner assuming fixed costs will be the same as last year.
  2. 3-53. ETHICS, CVP ANALYSIS. Megaphone Corporation produces a molded plastic casing, M&M101, for many cell phones currently on the market. Summary data from its 2020 income statement are as follows:
Megaphone Corporation 2020 income statement summary data

Revenues: 5,000,000 dollars

Variable costs: 3,250,000 dollars

Fixed costs: 1,890,000 dollars

Operating income: negative 140,000 dollars

  1. Joshua Kirby, Megaphone’s president, is very concerned about Megaphone Corporation’s poor profitability. He asks Leroy Gibbs, production manager, and Tony DiNunzo, controller, to see if there are ways to reduce costs.
  2. After 2 weeks, Leroy returns with a proposal to reduce variable costs to 55% of revenues by reducing the costs Megaphone currently incurs for safe disposal of wasted plastic. Tony is concerned that this would expose the company to potential environmental liabilities. He tells Leroy, “We would need to estimate some of these potential environmental costs and include them in our analysis.” “You can’t do that,” Leroy 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 and 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. Required
    2. 1. Calculate Megaphone Corporation’s breakeven revenues for 2020.
    3. 2. Calculate Megaphone Corporation’s breakeven revenues if variable costs are 55% of revenues.
    4. 3. Calculate Megaphone Corporation’s operating income for 2020 if variable costs had been 55% of revenues.
    5. 4. Given Leroy Gibbs’s comments, what should Tony DiNunzo do?
  3. 3-54. DECIDING WHERE TO PRODUCE. (CMA, adapted) Portal Corporation produces the same power generator in two Illinois plants, a new plant in Peoria and an older plant in Moline. The following data are available for the two plants:
Screenshot of a spreadsheet shows the details of the various parameters for the plants in Peoria and Moline.

  1. Peoria

    The details are given in two columns B and C

    • Row 2 shows Selling price in column C as 150.00 dollars

    • Row 3 shows Variable manufacturing cost per unit in column B as 72.00 dollars

    • Row 4 shows Fixed manufacturing cost per unit in column B as 30.00 dollars

    • Row 5 shows Variable marketing and distribution cost per unit in column B as 14.00 dollars

    • Row 6 shows Fixed marketing and distribution cost per unit in column B as 19.00 dollars

    • Row 7 shows Total cost per unit in column C as 135.00

    • Row 8 shows Operating income per unit in column C as 15.00 dollars

    • Row 9 shows Production rate per day as 400 units

    • Row 10 shows Normal annual capacity usage as 240 days

    • Row 11 shows Maximum annual capacity as 300 days

  2. Moline

    The details are given in two columns D and E

    • Row 2 shows Selling price in column E as 150.00 dollars

    • Row 3 shows Variable manufacturing cost per unit in column D as 88.00 dollars

    • Row 4 shows Fixed manufacturing cost per unit in column D as 15.00 dollars

    • Row 5 shows Variable marketing and distribution cost per unit in column D as 14.00 dollars

    • Row 6 shows Fixed marketing and distribution cost per unit in column D as 14.50 dollars

    • Row 7 shows Total cost per unit in column E as 131.50

    • Row 8 shows Operating income per unit in column E as 18.50 dollars

    • Row 9 shows Production rate per day as 320 units

    • Row 10 shows Normal annual capacity usage as 240 days

    • Row 11 shows Maximum annual capacity as 300 days

  1. 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 $3.00 per unit in Peoria and $8.00 per unit in Moline.
  2. Portal Corporation is expected to produce and sell 192,000 power generators during the coming year. Wanting to take advantage of the higher operating income per unit at Moline, the company’s production manager has decided to manufacture 96,000 units at each plant, resulting in a plan in which Moline operates at maximum capacity (320 units per day×300 days) and Peoria operates at its normal volume (400 units per day×240 days).
    1. Required
    2. 1. Calculate the breakeven point in units for the Peoria plant and for the Moline plant.
    3. 2. Calculate the operating income that would result from the production manager’s plan to produce 96,000 units at each plant.
    4. 3. Determine how the production of 192,000 units should be allocated between the Peoria and Moline plants to maximize operating income for Portal Corporation. Show your calculations.