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Margin of Safety Kearney Company, operating at full capacity, sold 400,000 units at a price of...

Margin of Safety

Kearney Company, operating at full capacity, sold 400,000 units at a price of $246.60 per unit during 2015. Its income statement for 2015 is as follows:

Sales $ 98,640,000
Cost of goods sold (44,500,000)
Gross profit $ 54,140,000
Expenses:
    Selling expenses $8,000,000
    Administrative expenses 3,000,000
        Total expenses (11,000,000)
Income from operations $ 43,140,000

The division of costs between fixed and variable is as follows:

Fixed Variable
Cost of good sold 28% 72%
Selling expenses 25% 75%
Administrative expenses 80% 20%

Management is considering a plant expansion program that will permit an increase of $8,631,000 (35,000 units at $246.60) in yearly sales. The expansion will increase fixed costs by $3,600,000 but will not affect the relationship between sales and variable costs.

Round the answers to one decimal place.

1. Margin of safety for 2015.
%

2. Margin of safety under the proposed program assuming 2015 sales.
%

Solutions

Expert Solution

Current Scenario
Break even sales = Fixed Cost / Cont. Margin ratio
= $ 16860000 / ($ 60000000 / $ 98640000)
= $ 27,717,840.00
Margin of Safety % = (Actual Sales - Break Even sales) / Actual Sales
= ($ 98640000 - $ 27717840) / $ 98640000
= 71.90%
Proposed Scenario
Break even sales = Fixed Cost / Cont. Margin ratio
= $ 20460000 / ($ 62500000 / $ 107217000)
= $ 33,636,240.00
Margin of Safety % = (Actual Sales - Break Even sales) / Actual Sales
= ($ 107271000 - $ 33636240) / $ 107271000
= 68.64%

Workings:

Scenarios
Particulars Current Per unit Proposed Per unit
Units 400000 435000
Sales $ 98,640,000.00 $ 246.60 $ 107,271,000.00 $ 246.60
Less: Variable Expenses $ 38,640,000.00 $    96.60 $   42,021,000.00 $    96.60
Contribution Margin $ 60,000,000.00 $ 150.00 $   65,250,000.00 $ 150.00
Less: Fixed Expenses $ 16,860,000.00 $   20,460,000.00
Income from operations $ 43,140,000.00 $   44,790,000.00
Particulars Total Fixed Variable
Cost of Goods sold $ 44,500,000.00 $ 12,460,000.00 (28%) $ 32,040,000.00 (72%)
Selling Expense $   8,000,000.00 $   2,000,000.00 (25%) $   6,000,000.00 (75%)
Administrative Expense $   3,000,000.00 $   2,400,000.00 (80%) $      600,000.00 (20%)
Total $ 55,500,000.00 $ 16,860,000.00 $ 38,640,000.00

ekkarill92 answered 3 years ago
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