Question

The Subway Sandwich Shop, Inc. is seeking to sell new franchises for its business. The company is in the process of developing a business plan to present to potential investors. Following are various projected cost data for a typical sandwich shop:

Lease of store space	$500/month
Equipment lease	$500/month
License	$240/year
Advertising	2.5% gross sales revenue
Royalty	8% of gross sales revenue
Salaries	$2,000/month
Utilities	$400/month
Insurance	$1,500/year

The average order (sandwich) sells for $4, with food cost of $2.

Required:

1. What is the contribution of each order (sandwich) toward covering fixed expenses?
2. What is the projected monthly breakeven point in units (round your answer up, to nearest whole unit)?
3. A potential franchisee has a target before-tax profit (π_B) of $2,000 per month. What level of sales (in units and in dollars, per month) must be achieved to meet the franchisee's profit goal (round up, to nearest whole unit)?
4. This potential franchisee has a target after-tax profit (π_A) of $1,800 per month. To achieve this profit objective, what level of sales (in units and in dollars, per month) must be achieved if the tax rate, t, is 35% (roundup to nearest whole unit)?
5. What is the degree of operating leverage (DOL) of a typical sandwich shop at the volume level needed to achieve a targeted before-tax profit (i.e., an operating income) of $2,000 per month? Round your answer to 2 decimal places.
6. From the sales volume level needed to achieve the monthly pre-tax profit (π_B) goal of $2,000, what would be the percentage change in π_B if sales increased by 5%?

Answer 1

1) Contribution margin for each order

Sale price per order	$4.00
Food cost	$2.00
advertising	$0.10
Royalty	$0.32
Contribution margin per order	$1.58

2) Monthly Breakeven point in units = fixed expenses per month / contribution margin per order

Lease of store space	$500
Equipment lease	$500
License	$20
Salaries	$2,000
Utilities	$400
Insurance	$125
Total fixed expenses	$3,545

Hence, Monthly breakeven points = 3545 / 1.58

= 2244 orders

3) Level of units per month for a required target profit = (fixed expenses + target profit) / contribtuion margin per unit

= (3545 + 2000) / 1.58

= 3,509 units

Level of sales in dollars = 3509 * 4

= $14,037.97

4) Before tax profit = 1800 / (1-0.35)

= $2769.23

Level of units per month for a required target profit = fixed expenses + before tax profits / contribtuion margin

= 3545 + 2769.23 / 1.58

= 3996 units

Level of sales in dollars = 3996 * 4

= $15,985

5) Degree of operating income = contribution margin / operaitng income

= 5545 / 2000

= 2.77

6) % change in pre tax profiy goal of $2000 with a 5% increase in sales

New operating income = contribution margin - fixed expenses

= ((3509*1.05)*1.58) - 3545

= 5822.25 - 3545

= $2277

% change in pre tax profit = (2277 - 2000) / 2000

= 14%