Question

Mary Willis is the advertising manager for Culver Shoe Store. She is currently working on a major promotional campaign. Her ideas include the installation of a new lighting system and increased display space that will add $14,000 in fixed costs to the $133,000 currently spent. In addition, Mary is proposing that a 5% price decrease ($20 to $19) will produce a 20% increase in sales volume (20,000 to 24,000). Variable costs will remain at $12 per pair of shoes. Management is impressed with Mary’s ideas but concerned about the effects that these changes will have on the break-even point and the margin of safety.

A)

Current break-even point_____________ pairs of shoes

New break-even point________________pairs of shoes

B)

Current Margin of safety ratio _________%

New margin of safety ratio _________%

C)

Prepare a cup income statement for current operations and after Mary's changes are introduced.

Income statement :

Answer 1

Formula to calculate Contribution margin per unit = Selling price per unit - Total variable cost per unit

==> Current Contribution margin per unit = $20 - $12 = $8

==> New Contribution margin per unit = $19 - $12 = $7

A) Formula to calculate Break-even point in units = Fixed costs / Contribution margin per unit

==> Current Break-even point = $133,000 / $8 =16,625 pairs of shoes

==> New Break-even point = ( $133,000 + $14,000) / $7 = $147,000 / $7 = 21,000 pairs of shoes

B) Formula to calculate Margin of safety = (Expected sales - Break-even sales) / Expected sales

==> Current margin of safety ratio = (20,000 - 16,625) / 20,000 = 3,375 / 20,000 = 16.875%

==> New margin of safety ratio = (24,000 - 21,000) / 24,000 = 3,000 / 24,000 = 12.5%

C)

CVP Income Statement for Current Operations
Sales (20,000 X $20)	$400,000
Less : Variable costs (20,000 X $12)	(240,000)
Contribution margin	160,000
Less : Fixed costs	(133,000)
Income / (Loss)	$27,000

CVP Income Statement After Mary's Changes
Sales (24,000 X $19)	$456,000
Less : Variable costs (24,000 X $12)	(288,000)
Contribution margin	168,000
Less : Fixed costs (133,000 +14,000)	(147,000)
Income / (Loss)	$21,000