Question

Much Moore Inc operates cafeteria food services in public buildings in the Southwest. Much Moore Inc is contemplating a major change in its cost structure. Currently, all of their cafeteria lines are staffed with hourly wage employees who hand serve the food to customers. Eric Moore, Much Moore’s owner, is considering replacing the employees with an automated self-service system. However, before making the change, Eric would like to know the consequences of the change, since the volume of business varies significantly from location to location. Shown below are the CVP income statements for each alternative.

                                                                        Personal Service        Automated Self-Service

                                                                              System                                  System ______              

                                    Sales                              $2,500,000                          $2,500,000

                                    Variable costs                  1,875,000                           1,125,000

                                    Contribution margin    $    625,000                          $1,375,000

                                    Fixed costs                          125,000                               875,000

                                    Net Income                   $    500,000                          $   500,000

Instructions

(a)        Determine the degree of operating leverage for each alternative.

(b)        Which alternative would produce the higher net income if sales increased by $250,000?

(c)        Using the margin of safety ratio, determine which alternative could sustain the greater decline in sales before operating at a loss.

(d)        Much Moore’s vice president of finance has offered another option. He suggests a different system that combines personal service at key points in the cafeteria line with a less expensive automated self -service system for the other items. The financial information on this system is given below:

                                                                        Blended Service        

                                                                              System                 

                                    Sales                              $2,500,000                           

                                    Variable costs                  1,500,000                          

                                    Contribution margin    $ 1,000,000                           

                                    Fixed costs                          500,000                             

                                    Net Income                   $    500,000

            (1)        Determine the degree of operating leverage for this option.

            (2)        How much would net income increase if sales increased by $250,000?

(3)        Using the margin of safety ratio, how large of a decline in sales could this option sustain before operating at a loss.

            (4)        Which option do you recommend for Much Moore Inc?

Answer 1