Question

A 2002 Income Statement for Anthony Industries, using a contribution margin approach, is shown below. Anthony makes only one product. 50,000 units were sold in 2002.

Data 1

Revenues                                                                                $650,000

Variable Costs:

Manufacturing costs                          $290,000

Selling costs                                        130,000

Total variable costs                                                                 420,000

Contribution margin                                                               $230,000

Fixed Costs:

Manufacturing costs                          $110,000

Administrative costs                             70,000

Total fixed costs                                                                    180,000

Net Income (before taxes)                                                     $50,000

Requirements: 2 points each part

Answer the following questions. Assume each situation is independent.  

  

a)     Determine the break-even point in dollars.

b)  Determine the number of units that must be sold to produce a before tax profit of $200,000 if the tax rate is 30%.    

c) Determine the number of units that must be sold to produce an after tax profit of $200,000 if the tax rate is 30%.    

d)  Calculate the expected change in a company’s net income if it undertakes an advertising program that costs $25,000 and increases sales $60,000.  

e)    Assume that the company is considering another product. They estimate that the product will have variable costs of $20 per unit and demand will be 25,000 units.  The fixed costs of developing the product will be $165,000. What is the lowest price the company should charge for the potential product given this information?

f)     What is the company’s degree of operating leverage? What percentage will profits increase if unit sales increase 10%?

Answer 1

Question A

Break Even Point in Dollars = Fixed Costs / Contribution Margin Ratio

Fixed Costs = $ 180,000

Contribution Margin Ratio = Contribution Margin / Total Sales * 100

Contribution Margin = $ 230,000

Total Sales = $ 650,000

Contribution Margin Ratio = 230,000 / 650,000 * 100

Contribution Margin Ratio = 35.38%

Break Even Point in Dollars = 180,000 / 35.38%

Break Even Point in Dollars = $ 508,696

Question B

Units to be sold to earn Operating Pretax Profit of $ 200,000 = (Target Pretax Profit + Total Fixed Costs) / Contribution Margin per Unit

Contribution Margin per Unit = Total Contribution Margin / Number of Units Sold

Contribution Margin per Unit = 230,000 / 50,000

Contribution Margin per Unit = $ 4.60 per Unit

Total Fixed Costs = $ 180,000

Target Pretax Profit = $ 200,000

Units to be sold to earn Target Pretax Profit = (200,000 + 180,000) / 4.60

= 380,000 / 4.60

= 82,609 Units

Question 3

After Tax Profit = Pre-tax Profit * (1- Tax Rate%)

After Tax Profit = $ 200,000

Tax Rate = 30%

200,000 = Pretax Profit * (1-30%)

200,000 = Pretax Profit * 70%

Pretax Profit = 200,000 / 70%

Pretax Profit = $ 285,715

Units to be Sold to earn Target After Tax Profit of $ 200,000 = (Pretax Profit + Total Fixed Costs) / Contribution Margin per Unit

Contribution Margin per Unit = $ 4.6

Total Fixed Costs = $ 180,000

Pretax Profit = $ 285,715

Units to be sold to earn Target After Tax Profit of $ 200,000 = (285,715 + 180,000) / 4.60

= 465,715 / 4.60

= 101,242 Units

Question 4

Net Income after Additional Advertising Costs = Contribution Margin Ratio * Increase in Sales - Additional Advertising Costs

Additional Advertising Costs = $ 25,000

Contribution Margin Ratio = 35.38%

Increase in Sales = $ 60,000

Net Income after Additional Advertising Costs = (35.38% * 60,000) - 25,000

Increase / (Decrease) in Net Operating Income= ($ 3,769)

Important Points:-

For Questions 1 to 4 All the Calculation were in multiple fraction which has been rounded off for convenience but the Calculation of the answers has been done by keeping the actual answers in multiple fraction so if you have any problem with minor differences due to rounding off please check the Calculation using the figure provided for getting the answers.

Question 5

Lowest that Company should charge should be a point where there will be no profit or loss which means Profit = 0

Profit = Sales in Units * (Sales Price per Unit - Variable Costs per Unit) - Fixed Costs

Sales in Units = 25,000 Units

Profit = 0

Variable Costs per Unit = $ 20

Fixed Costs = $ 165,000

Using Formula for Profit

0 = 25,000 * (Sale Price per Unit - 20) - 165,000

0 = 25,000 * Sales Price per Unit - 500,000 - 165,000

0 + 500,000 + 165,000 = 25,000 * Sales Price per Unit

Sales Price per Unit = 665,000 / 25,000

Sales Price per Unit = $ 26.60

Minimum Sales Price the Company should charge = $ 26.60 per Unit

Question 6

Degree of Operating Leverage = Contribution Margin / Operating Income

Contribution Margin = $ 230,000

Operating Income = $ 50,000

Degree of Operating Leverage = 230,000 / 50,000

Degree of Operating Leverage = 4.6 Times

Calculation of Increase in Income after Increase in Sales by 10%

Degree of Operating Leverage = % Increase in Operating Income / % Increase in Sales

4.6 = % Increase in Operating Income / 10%

4.6 * 10 = % Increase in Operating Income

Increase in Operating Income = 46%

Profit will increase by 46%