Question

Mirabel Manufacturing is a small but growing company that manufactures and sells marine sonar equipment. They employee a national sales force and their primary customers are marine retailers and boat dealerships. The company has expanded over the last 5 years and Paul Mirabel, the founder and CEO has become concerned that he no longer has a clear picture of their cost structure. He calls his CFO, Mary Jane Montgomery in for a meeting. “Mary Jane, I am concerned that I am not current on our cost structure and how that is impacting our bottom line,” Paul begins. “Well, Paul, the company has grown considerably over the past 5 years, so I’m not surprised that you feel a little disconnected with how things are going,” Mary Jane replied. She continued “In fact, I’ve been meaning to talk to you about a couple of big items such as increasing the sales commission to 15%. We’ve lost two of our best account managers in the last 9 months. It seems like we are behind the curve paying only 12% on gross sales.” “What do you mean we are behind the curve,” Paul replied angrily. “We have always been the leader in every aspect of our business.” “Well, that may have been the case in the past, Paul, but frankly we need to step up our compensation package to stay competitive,” Mary Jane replied. She continued, “And that’s not everything. I met with Frank Jacobs from marketing and he said we need to have a bigger presence at the trade show in March. He told me he would need about $650,000 added to the marketing budget to support new marketing materials.” “Come on, Mary Jane, how can we do that when we are going to have to increase commission?” He continued, “I spoke with Dan Clark in production and he indicated that we have two pieces of equipment that need to be replaced by the end of the quarter and that’s going to set us back almost $1.2 million.” Mary Jane shook her head. “Paul, I hate to bring this up but while we are talking costs, but Bob in purchasing stopped by the office and dropped off some revised cost information – it looks like several of our suppliers are talking about significant price increases by the end of the year.” Paul slumped in his chair. “This is a mess, Mary Jane. Increasing commissions, new equipment, materials price increases and marketing expenses all at once. Even if Frank Mallow is correct that we should see a 10% increase in sales for the coming year, I just don’t see how we can make this work. We have to maintain enough profit to keep the shareholders happy and I can’t sleep when we dip below that $2 million margin of safety.” Mary Jane gathered up her papers. “Before you get too distressed, let me put together some figures and let’s see what this looks like on paper. I’ll get back to you by the end of the week. In the meantime, stay positive, we’ll find the best solution.” The following income and cost data for Mirabel is provided: Mirabel Manufacturing Budgeted Income Statement For the Year Ending December 31 Sales $ 36,750,000 Cost of goods sold: Variable $ 13,300,000 Fixed $ 9,300,000 Gross Margin $ 14,150,000 Selling & Administrative Commissions $ 4,410,000 Fixed Marketing Expenses $ 1,350,000 Fixed Administrative $ 6,000,000 Net Operating Income $ 2,390,000 Model 101 Model 201 Model 301 Normal Annual Sales Volume 16,000 19,000 11,000 Unit Selling Price $ 650 $ 750 $ 1,100 Variable expense per unit $ 250 $ 200 $ 500 (Note: Each of the following questions is independent of the others) What is Mirabel’s over-all break-even point in sales dollars? Assume that sales revenue remains constant, what is the impact on break-even and the margin of safety if Paul takes Mary Jane’s advice and increases sales commission to 15%? If Mirabel purchases the new equipment for $1,200,000, it will increase fixed costs by 10% but will decrease the variable cost per unit for all 3 models by 5%. What will Mirabel’s new break-even point be? If Mirabel invests the additional $650,000 in fixed marketing expenses, sales of the Model 301 are expected to increase by 8%. What is the break-even and margin of safety under these circumstances? If the projection is that sales will increase by 10% in the coming year, can the company afford to also increase commission from 12% to 15%? Why or why not. Assume that sales volume remains fixed but there is a 5% increase in variable expenses (materials cost) for the Model 101 and 301, and a 10% increase in variable expenses for Model 201. What is the new break-even? Report: Prepare a report from Mary Jane to Don explaining how these changes will affect Mirabel’s overall cost structure. For those changes that are controllable, make a recommendation considering the uncontrollable cost changes. Be certain to consider not only the company’s break-even point, but also the desired margin of safety. Expert Answer for Report at bottom

Answer 1

1. Formula for break even point in unit is

Fixed cost/contribution margin per unit

Here Fixed cost =Fixed Cost of goods sold + Fixed Marketing Expenses +Fixed Administrative

= $9,300,000 + $1,350,000+ $6,000,000 = $16,650,000.

Contribution Margin per unit= Sales Per unit - variable expenses Per unit

Sales

Model 101 = 16000 units x $650 =$10,400,000

Model 201 = 19000 units x $750 =$14,250,000

Model 301 = 11000 units x $1100= $12,100,00

Hence Total Sales =$36,750,000

Sales Per unit = $36,750,000/(16000 units +19000 units +11000 units) =$798.91

Variable expenses per unit = ($13,300,000+ $4,410,000)/46000 units = $385

Hence Contribution Margin = ($798.91- $385)=$413.91

Hence Break even point in Units = $16,650,000/$413.91= 40,226 units

Hence Break Even point in Sales Dollars = Sales Price X Break Even point units = $798.91 x 40,226 units =$32,136,954.

2. If Sales commission increases from 12% to 15% then sales commission increase per unit = ($36,750,000 x(15%-12%))/46000 units =$23.97

And variable expenses per unit = $385 + $23.97=$408.97

Hence Contribution margin per unit = $789.91 - $408.97 = $380.94

Break even point in units = $16,650,000/$380.94= 43,708 units

Hence Break Even point Sales in Dollars = 43,708 units x $789.91=$34,525,386.

Margin of Safety = Actual Sales - Break Even points = $36,750,000-$34,525,386 =$2,224,614.

3. If fixed costs increase by 10% then new fixed cost would be =$16,650,000 x 110%=$18,315,000

If variable expense reduce by 5% then new variable expenses per unit =($289.13 x 95%) + (4,410,000/46,000) =$370.54

(It is assumed that variable costs other than sales commission are reduced by 5%)

Contribution margin per unit =$798.91 - $370.54 = $428.37

Break even points in units = $18,315,000/$428.37 = 42,755 units

Break even point in Sales Dollars = 42,755 units x $798.91 = $34,157,397

4. .If $650,000 is invested in fixed marketing expenses then fixed cost would stand = $16,650,000 + $650,000 = $17,300,000

if Sales of model 301 is increased by 8% then total sales would be

Model 101 = 16000 units x $650= $10,40,0000

Model 201 = 19000 units x $750= $14,250,000

Model 301 = (11000 units x 108%) x $1100 =$13,068,000

Total sales units =46880 units and Sales = $37,718,000 ,Sales Per unit =$804.56

Contribution margin per unit =$804.56 - $385 = $419.56

Break even point in units =$17,300,000/$419.56 = 41,234 units

Break even points in Sales Dollars = 41,234 units x $804.56= $33,175,227

Note : We are allowed to solve only 4 sub parts of the question, if such sub-parts are related to same question. Therefore, first 4 sub-parts have been solved as no specific sub-parts are requested in the question to solve.