Question

Hot Tubs Unlimited Purchases hot tubs from a well-known munufacturere and sells them at retail level. The hot tubs sell, on average, for $2,500 each. The average cost for a hot tub from the manufacturer is $1,500.

The January 2018 monthy costs for the company are listed:

Costs	Cost Formula
Selling:
Advertising	$950 per month
Delivery of hot tubs	$60 per hot tub sold
Sales salaries and commisions	$3,800 per month, plus 4% of sales
Utilites	$650 per month
Depreciation on sales facilities	$5,000 per month
Administrative:
Executive salaries	$13,500 per month
Depreciation on office equipment	$900 per month
Clerical	$2,500 per month, plus $40 per hot tub sold
Insurance	$700 per month

During January the company sells 60 hot tubs.

Required:

1. Calculate the margin of safety and the margin of safety percentage.

2. Calculate the degree of operating leverage.

3. The company would like to earn $38,000 of net operating income. What will be the required sales in units and dollars.

Answer 1

Variable costs per hot tub = Cost of hot tub + Delivery of hot tubs + Sales salaries and commisions + Clerical per hot tub

= $1,500 + $60 + ($2,500*4%) + $40

= $1,700

Fixed costs = Advertising + Sales salaries and commisions + Utilities + Depreciation on sales facilities + Executive salaries + Depreciation on office equipment + Clerical + Insurance

= $950 + $3,800 + $650 + $5,000 + $13,500 + $900 + $2,500 + $700

= $28,000

1.

Contribution margin per hot tub = Selling price per hot tub - Variable costs pet hot tub

= $2,500 - $1,700

= $800

Breakeven units = Fixed costs / Contribution margin per hot tub

= $28,000 / $800

= 35

Margin of safety = Sales - Breakeven sales

= 60 - 35

= 25

Margin of safety percentage = Margin of safety / Sales

= 25 / 60

= 41.67%

2.

Contribution margin = Contribution margin per hot tub * Number of hot tubs sold

= $800 * 60

= $48,000

Net income = Contribution margin - Fixed costs

= $48,000 - 28,000

= $20,000

Degree of opertaing leverage = Contribution margin / Net income

= $48,000 / $20,000

= 2.4

3.

Required sales in units = (fixed costs + desired income) / Contribution margin per hot tub

= ($28,000 + $38,000) / $800

= 83 units

Required sales in dollars = 83 units * $2,500

= $207,500