Question

Zachary Company is considering the addition of a new product to its cosmetics line. The company has three distinctly different options: a skin cream, a bath oil, or a hair coloring gel. Relevant information and budgeted annual income statements for each of the products follow. Relevant Information Skin Cream Bath Oil Color Gel Budgeted sales in units (a) 140,000 220,000 100,000 Expected sales price (b) $ 7 $ 7 $ 15 Variable costs per unit (c) $ 2 $ 4 $ 11 Income statements Sales revenue (a × b) $ 980,000 $ 1,540,000 $ 1,500,000 Variable costs (a × c) (280,000 ) (880,000 ) (1,100,000 ) Contribution margin 700,000 660,000 400,000 Fixed costs (585,000 ) (585,000 ) (136,000 ) Net income $ 115,000 $ 75,000 $ 264,000

Required

a.Determine the margin of safety as a percentage for each product.

b.Prepare revised income statements for each product, assuming a 20 percent increase in the budgeted sales volume.

c.For each product, determine the percentage change in net income that results from the 20 percent increase in sales.

d.Assuming that management is pessimistic and risk averse, which product should the company add to its cosmetics line?

e.Assuming that management is optimistic and risk aggressive, which product should the company add to its cosmetics line?

Answer 1

a) margin of safety =(( budget sale - break even sale ) / budgeted sale ) *100

skin cream   = ((980000 - 818984) / 980000)*100 = 16.4%

contribution margin = 700000 / 980000 =71.43%

break even sale = 585000 / 71.43% = 818984

bath oil = ((1540000 - 1365865 ) / 1540000 )*100 = 11.31%

contribution margin = 660000 / 1540000 = 42.83%

break even sale = 585000 / 42.83% = 1365865

hair color gel = ((1500000 - 509936) / 1500000) *100 = 66%

contribution margin = 400000 / 1500000 = 26.67%

break even sale = 136000 / 26.67% = 509936

b)

d) if the company is pessimistic and risk averse the company would choose not take option with more risk

break even units = fixed cost / contribution per unit

skin cream = 585000 /(7-2) =117000 units

bath oil = 585000 / ( 7 -4) =195000 units

hair gel = 136000 / (15 - 11) = 34000 units

if the company is pessimistic and risk averse then choose hair gel add to their cosmetics line so that with minimum units company can acheive break even sales

e) if the company is optimistic and risk aggressive then company willing to take risk and earn higher return

margin of safety units = budgeted units - break even units

skin cream =140000 - 117000 units = 23000units

bath oil = 220000 - 195000 units = 25000units

hair gel =100000 - 34000 units = 66000units

if the company is optimistic and risk aggressive then company will choose hair gel because company can earn more net income