Question

Superior Real Estate Agency has opened an office in Collins Street Melbourne. The average monthly property sales is $900,000 and the Estate agent generates its revenue via charging a commission (agency revenue) of 6.0% of the gross property sales. Fixed monthly costs are office rent ($4,000), depreciation of office furniture ($500), electricity ($700), a multi-line telephone system ($600), computer cabling connection ($400) and salary of the office manager ($8500). Variable costs include commissions for the sales staff (55% of agency revenue), supplies and printing (12% of agency revenue), and usage costs for phone and computers (9% of agency revenue).

REQUIRED

Calculate the estate agency’s monthly break even commission / agency revenue in dollars.

Calculate the commission / agency revenue needed to earn monthly net profit of $15,000.

From your answer in (b) above, what is the gross property sales required to generate commission / agency revenue to make a $15,000 profit above breakeven.

When the managing partner of Superior Estate Agency is shown your Cost Volume Profit calculations, he is quite dismissive. He says it is largely useless information because the reality of the real estate business is much more complex and dynamic with the model based on unrealistic assumption.   Prepare a detailed response to the managing partner, identifying model assumptions and potential use of the model. (100 words limit)

Answer 1

a) Formula for Break even revenue = Fixed expense/Contribution margin ratio

Fixed expenses don't changes along with production whereas variable expenses changes along with production.

Fixed expenses :

Rent = $ 4,000

Depreciation = $ 500

Electricity = $ 700

Telephone system =$ 600

Computer connection = $400

salary of office management =$ 8,500

Total fixed expense = $14,700

Variable expense :

Agency revenue = Property sales * 6%= 900,000*6%=$54,000

Sales staff = $54,000*55%=$29,700

Supplies and printing = $54,000*12%=$6,480

Usage and cost of phone and computers =$54,000*9%=$4,860

Total Variable Expenses = $410,40

Contribution = revenue - Variable expense= $54,000-$410,40=$12,960

Contribution margin ratio= Contribution / revenue=$12,960/54,000=0.24

Break even revenue = Fixed expense/Contribution margin ratio= $14,700/0.24=$61,250

b) the commission / agency revenue needed to earn monthly net profit of $15,000.

Agency revenue = Fixed expense + Target profit / Contribution marginratio

=$14,700+15,000/0.24=$123,750

c) gross property sales required to generate commission / agency revenue to make a $15,000 profit above breakeven.

= $123,750/0.06 =$2,062,500

d) Cost Volume Profit assumptions and potential use of model:

Simply CVP assumes the following:

• Constant sales price throughout calculation
• Constant variable cost per unit
• Constant total fixed cost
• Units sold equal units produced

Potential use :

CVP helps to figure out how changes cost and vloume affect operating expense and net income.By segregating costs in to fixed and variable helps companies insight into the profitability of products and services.