Question

Introduction: Having the ability to effectively communicate is one of the most important skills a business executive can possess. As French businesswoman and author Mirelle Guilliano has said, “Intelligence, knowledge or experience are important and might get you a job, but strong communication skills are what will get you promoted.” My own business experience supports this statement. By the time individuals have a few years of experience, they have great technical skills and can assemble, analyze, and categorize data to make solid business decisions. In the end, however, they are often unable to communicate the results of their analysis effectively. When I speak to senior executives and inquire about educational needs, the conversation invariably turns to communications. In accounting, by necessity, we focus on financial and quantitative data, but it is important to remember that as accountants we must be able to present the results of our analysis or studies to management. Through effective communications, accountants can truly impact business decisions and make their careers soar. The best way to get better at anything is to practice. That’s the basis for this assignment – to practice written communication.

Situation for Analysis: Grayslake Novelty produces and sells a small novelty item through tourist shops in Chicago and other northern Illinois locations. Last year the company sold 198,400 units. The income statement for Grayslake Novelty for last year is shown below:

Sales	$992,000
Less: Variable Expenses	545,600
Contribution Margin	446,400
Less: Fixed Costs	180,000
Net Operating Income	$266,400

While the company has been profitable, as shown in the above income statement, sales began falling near the end of last year and have continued to decline this year. There is concern that new competitors are beginning to take market share from Grayslake Novelty. As a result, Sarah Burroughs, the company president, has asked you to provide some information to assist her in making decisions about the company’s strategy for this product. These alternatives should be evaluated individually as stated. You are free to offer your own alternative based on any of the parameters given in the data.

Required:

a. While the company is currently profitable, the president wants to know the contribution margin and the breakeven in both units and dollars using last year’s level of sales. Additionally, compute the margin of safety, margin of safety ratio, and degree of operating leverage based on last year’s sales.

b. One of the possible strategies (Alt 1) is to reduce the current price by 8%. Using last year’s level of sales, what is the new contribution margin and break-even in units and dollars based on the price reduction? Additionally, compute the margin of safety, margin of safety ratio, and degree of operating leverage based on last year’s sales.

c. A second strategy (Alt 2) is to reduce the current variable cost by 0.20 per unit. The company has identified available efficiencies that can be implemented without any additional changes to the current cost. What is the new contribution margin and break-even in units and dollars based on the variable cost reduction of 0.20 per unit? Additionally, compute the margin of safety, margin of safety ratio, and degree of operating leverage based on last year’s sales.

d. A third strategy (Alt3) is to decrease the current price by 8% and reduce the variable cost per unit by 0.20. What is the new contribution margin and break-even in units and dollars based on making both changes? Additionally, compute the margin of safety, margin of safety ratio, and degree of operating leverage based on last year’s sales.

e. A fourth strategy (Alt 4) under consideration is to invest in more automated equipment for the manufacturing process. This investment will reduce variable costs by 0.65 per unit, primarily reducing the direct labor. At the same time, this will increase the fixed costs by $50,000. What is the new contribution margin and break-even in units and dollars based on this change in operating structure? Additionally, compute the margin of safety, margin of safety ratio, and degree of operating leverage based on last year’s sales.

f. A final strategy (Alt 5) is to change the current structure for the company’s sales person. The current fixed cost includes the salary of Grayslake’s one sales person at $60,000 per year. The company’s marketing study suggests that sales could be increased by 20% if the company hired an additional sales person; paid both individuals $40,000 fixed salaries; and a 0.25 commission per unit sold. What is the new contribution margin and break-even in units and dollars based on this change? Additionally, compute the margin of safety, margin of safety ratio, and degree of operating leverage based on last year’s sales as the starting point for this change.

(I already did this, but I have absolutely no idea if my numbers match with the requirements needed)

Answer 1

a.)
Particulars	Existing situation
Volume	1,98,400
Sales	$                                     9,92,000
Variable costs	$                                     5,45,600
Contribution	$                                     4,46,400
Less: Fixed costs	$                                     1,80,000
Net operating Income	$                                     2,66,400
Contribution margin ratio	Cont / sales *100
Contribution margin ratio	45.00%
Breakeven (units)	Fixed costs / (S.P - V.cost p.u)
S.P	$                                            5.00
V.cost p.u	$                                            2.75
Breakeven (units)	80,000.00
S.P	$                                            5.00
Breakeven (value)	$                               4,00,000.00
Margin of safety	Sales - breakeven sales (value)
Margin of safety	$                               5,92,000.00
Margin of safety ratio	Margin of safety / sales *100
Margin of safety ratio	59.68%
Degree of operating leverage	Contribution / net income
Degree of operating leverage	1.68
b.)
Particulars	Alt 1
Volume	1,98,400
Sales	$                                     9,12,640
Variable costs	$                                     5,45,600
Contribution	$                                     3,67,040
Less: Fixed costs	$                                     1,80,000
Net operating Income	$                                     1,87,040
Contribution margin ratio	Cont / sales *100
Contribution margin ratio	40.22%
Breakeven (units)	Fixed costs / (S.P - V.cost p.u)
S.P	$                                            4.60
V.cost p.u	$                                            2.75
Breakeven (units)	97,297.30
Breakeven (units rounded off)	97,298.00
S.P	$                                            4.60
Breakeven (value)	$                               4,47,570.80
Margin of safety	Sales - breakeven sales (value)
Margin of safety	$                               4,65,069.20
Margin of safety ratio	Margin of safety / sales *100
Margin of safety ratio	50.96%
Degree of operating leverage	Contribution / net income
Degree of operating leverage	1.96
c.)
Particulars	Alt 2
Volume	1,98,400
Sales	$                                     9,92,000
Variable costs	$                                     5,05,920
Contribution	$                                     4,86,080
Less: Fixed costs	$                                     1,80,000
Net operating Income	$                                     3,06,080
Contribution margin ratio	Cont / sales *100
Contribution margin ratio	49.00%
Breakeven (units)	Fixed costs / (S.P - V.cost p.u)
S.P	$                                            5.00
V.cost p.u	$                                            2.55
Breakeven (units)	73,469.39
Breakeven (units rounded off)	73,470.00
S.P	$                                            5.00
Breakeven (value)	$                               3,67,350.00
Margin of safety	Sales - breakeven sales (value)
Margin of safety	$                               6,24,650.00
Margin of safety ratio	Margin of safety / sales *100
Margin of safety ratio	62.97%
Degree of operating leverage	Contribution / net income
Degree of operating leverage	1.59
d.)
Particulars	Alt 3
Volume	1,98,400
Sales	$                                     9,12,640
Variable costs	$                                     5,05,920
Contribution	$                                     4,06,720
Less: Fixed costs	$                                     1,80,000
Net operating Income	$                                     2,26,720
Contribution margin ratio	Cont / sales *100
Contribution margin ratio	44.57%
Breakeven (units)	Fixed costs / (S.P - V.cost p.u)
S.P	$                                            4.60
V.cost p.u	$                                            2.55
Breakeven (units)	87,804.88
Breakeven (units rounded off)	87,805.00
S.P	$                                            4.60
Breakeven (value)	$                               4,03,903.00
Margin of safety	Sales - breakeven sales (value)
Margin of safety	$                               5,08,737.00
Margin of safety ratio	Margin of safety / sales *100
Margin of safety ratio	55.74%
Degree of operating leverage	Contribution / net income
Degree of operating leverage	1.79
e.)
Particulars	Alt 4
Volume	1,98,400
Sales	$                                     9,92,000
Variable costs	$                                     4,16,640
Contribution	$                                     5,75,360
Less: Fixed costs	$                                     2,30,000
Net operating Income	$                                     3,45,360
Contribution margin ratio	Cont / sales *100
Contribution margin ratio	58.00%
Breakeven (units)	Fixed costs / (S.P - V.cost p.u)
S.P	$                                            5.00
V.cost p.u	$                                            2.10
Breakeven (units)	79,310.34
Breakeven (units rounded off)	79,311.00
S.P	$                                            5.00
Breakeven (value)	$                               3,96,555.00
Margin of safety	Sales - breakeven sales (value)
Margin of safety	$                               5,95,445.00
Margin of safety ratio	Margin of safety / sales *100
Margin of safety ratio	60.02%
Degree of operating leverage	Contribution / net income
Degree of operating leverage	1.67
f.)
Particulars	Alt 5
Volume	2,38,080
Sales	$                                  11,90,400
Variable costs	$                                     7,14,240
Contribution	$                                     4,76,160
Less: Fixed costs	$                                     2,00,000
Net operating Income	$                                     2,76,160
Contribution margin ratio	Cont / sales *100
Contribution margin ratio	40.00%
Breakeven (units)	Fixed costs / (S.P - V.cost p.u)
S.P	$                                            5.00
V.cost p.u	$                                            3.00
Breakeven (units)	1,00,000.00
Breakeven (units rounded off)	1,00,000.00
S.P	$                                            5.00
Breakeven (value)	$                               5,00,000.00
Margin of safety	Sales - breakeven sales (value)
Margin of safety	$                               6,90,400.00
Margin of safety ratio	Margin of safety / sales *100
Margin of safety ratio	58.00%
Degree of operating leverage	Contribution / net income
Degree of operating leverage	1.72