Question

Simon Teguh is considering investing in a vending machine operation involving 20 vending machines located in various plants around the city. The machine manufacturer reports that similar vending machine routes have produced a sales volume ranging from 600 to 800 units per machine per month. The following information is made available to Teguh in evaluating the possible profitability of the operation.

An investment of $45,000 will be required, $9,000 for merchandise and $36,000 for the 20 machines.

The machines have a service life of five years and no salvage value at the end of that period. Depreciation will be computed on the straight-line basis.

The merchandise (candy and soft drinks) retails for an average of 75 cents per unit and will cost Teguh an average of 25 cents per unit.

Owners of the buildings in which the machines are located are paid a commission of 5 cents per unit of candy and soft drinks sold.

One person will be hired to service the machines. The salary will be $1,500 per month.

Other expenses are estimated at $600 per month. These expenses do not vary with the number of units sold.

Required:

a. Determine the unit contribution margin and the break-even volume in units and in dollars per month. Round "Unit contribution margin" to 2 decimal places

c. What sales volume in units and in dollars per month will be necessary to produce an operating income equal to a 30 percent annual return on Teguh's $45,000 investment? do not round

d. Teguh is considering offering the building owners a flat rental of $30 per machine per month in lieu of the commission of 5 cents per unit sold. What effect would this change in commission arrangement have on his monthly break-even volume in terms of units?

Answer 1

Solution

Simoh Teguh

1. Determination of unit contribution margin and the break even volume in units and dollars per month:

Selling price per candy sold = $0.75

Total Cost per candy –

Cost = $0.25

Commission = $0.05

Total variable cost = $0.25 + $0.05 = $0.30

Contribution margin per candy sold = $0.75 - $0.30 = $0.45

1. Break-even volume in units and dollars per month –

Break-even point in units = fixed cost/contribution margin per unit

Total fixed cost –

Depreciation on 20 machines per month = $36,000 x 1/5 x 1/12 = $600 per month

Salary = $1,500 per month

Fixed cost per month = $2,100

Break-even volume in units = $2,100/$0.45 = 4,667 units

Break-even volume in dollars = fixed cost/CM ratio

Fixed cost per month = $2,100

CM ratio = $0.45/$0.75 = 60%

Break-even volume in dollars = $2,100/60% = $3,500

1. Determine target sales volume in units and dollars per month:

Desired annual net income = 30% of $45,000 = $13,500

Desired monthly net income = 13,500/12 = $1,125

Fixed cost = $2,100

Desired sales in units = (fixed cost + target monthly income)/contribution margin per unit

Desired monthly sales in units = (2,100 + 1,125)/0.45 = 7,167 units

Desired monthly sales in dollars = (fixed cost + target monthly income)/contribution margin ratio

Desired monthly sales in dollars = (2,100 + 1,125)/60% = $5,375

1. Effects of flat rent of $30 per month in lieu of $0.05 commission on monthly break-even volume in units –

Monthly rent = $30 per month per machine

Monthly rent = $30 x 20 machines = $600

Fixed cost = $2,100 + $600 = $2,700

Revised CM = $0.75 - $0.25 = $0.50

Revised Break-even volume in units = $2,700/$0.50 = 5,400 units

Break-even volume in units increases by 733 units per month (5,400 – 4,667 = 733)