Question

Lorge Corporation has collected the following information after its first year of sales. Sales were $2,875,000 on 115,000 units; selling expenses $250,000 (40% variable and 60% fixed); direct materials $1,655,900; direct labor $250,000; administrative expenses $270,000 (20% variable and 80% fixed); and manufacturing overhead $343,000 (70% variable and 30% fixed). Top management has asked you to do a CVP analysis so that it can make plans for the coming year. It has projected that unit sales will increase by 10% next year.

(a)

Compute (1) the contribution margin for the current year and the projected year, and (2) the fixed costs for the current year. (Assume that fixed costs will remain the same in the projected year.)

(1)		Contribution margin for current year		$
		Contribution margin for projected year		$
(2)		Fixed costs for current year		$

Compute the break-even point in units and sales dollars for the first year.

Break-even point units
Break-even point $
   

The company has a target net income of $ 318,060 . What is the required sales in dollars for the company to meet its target?

Sales dollars required for target net income $

If the company meets its target net income number, by what percentage could its sales fall before it is operating at a loss? That is, what is its margin of safety ratio?

Margin of safety ratio %

The company is considering a purchase of equipment that would reduce its direct labor costs by $ 106,704 and would change its manufacturing overhead costs to 30% variable and 70% fixed (assume total manufacturing overhead cost is $ 369,360 , as above). It is also considering switching to a pure commission basis for its sales staff. This would change selling expenses to 90% variable and 10% fixed (assume total selling expense is $ 246,240 , as above). Compute (1) the contribution margin and (2) the contribution margin ratio, and recompute (3) the break-even point in sales dollars. (Round contribution margin ratio to 0 decimal places, e.g. 25% and all other answers to 0 decimal places, e.g. 2,520.)

1. Contribution margin
2. Contribution margin ratio %
3. Break-even point

Answer 1

Calculation of variable expenses per unit:

Selling Expenses 250,000*40% = $100,000

Direct Materials = $1,655,900

Direct Labor = $250,000

Admin Expenses 270,000*20% = $54,000

Manufacturing Overhead = 343,000*70% = $240,100

Total Variable costs = $2,300,000

Variable expense per unit = 2,300,000/115,000 = $20 per unit

Selling price per unit = $2,875,000/115,000 = $25

1)Contribution Margin for Current year = (25-20)*115,000 = $575,000

Contribution margin for projected year = (25-20)*126,500 = $632,500

2)Fixed costs for current year = 250,000*60% +270,000*80% + 343,000*30%

= $468,900

Break-even point units = Fixed Costs/Contribution Margin per unit

= 468,900/5

= 93,780 units

Break-even point $ = 93,780*25 = $2,344,500

Target Income = $318,060

Add; Fixed Costs = 468,900

Desired Contribution Margin = $786,960

Sales dollars required for target net income $ = 786,960*25/5 = $3,934,800

Margin of safety ratio % = (Sales – Break even sales)/sales

= (3,934,800-2,344,500)/3,934,800

= 40.42%

Computation of variable cost per unit

Selling Expenses 246,240*90% = $221,616

Direct Materials = $1,655,900

Direct Labor = $250,000- $106,704 = $143,296

Admin Expenses 270,000*20% = $54,000

Manufacturing Overhead = 369,360*30% = $110,808

Total Variable costs = $2,185,620

Variable expense per unit = 2,185,620/115,000 = $19 per unit

Contribution Margin Ratio = 19/25

= 76%

Break even point = 499,176/76%

= $656,810.53