Question

Problem 3-24B Assessing simultaneous changes in CVP relationships using the equation method

Milton Company sells tennis racquets; variable costs for each are $45, and each is sold for $135. Milton incurs $540,000 of fixed operating expenses annually.

Required

Determine the sales volume in units and dollars required to attain a $270,000 profit. Verify your answer by preparing an income statement using the contribution margin format.

Milton is considering establishing a quality improvement program that will require a $15 increase in the variable cost per unit. To inform its customers of the quality improvements, the company plans to spend an additional $150,000 for advertising. Assuming that the improvement program will increase sales to a level that is 5,000 units above the amount computed in Requirement a, should Milton proceed with plans to improve product quality? Support your answer by preparing a budgeted income statement.

Determine the new break-even point and the margin of safety percentage, assuming Milton adopts the quality improvement program. Round your figures to two decimal points.

Prepare a break-even graph using the cost and price assumptions outlined in Requirement c.

Answer 1

• All working forms part of the answer
• Working

Sale price per unit	$135
variable cost per unit	$45
Contribution margin per unit	$90

• Requirement 1: Units required to earn profit of $270000

Expected profit	$270000
Fixed Expenses	$540000
Total contribution required (A)	$810000
Contribution margin per unit (B)	$90
Units required to be sold (C=A/B)	9000
Sales in $ (D=C x $135)	$1215000

Verification of above

A	Sales Revenue $	1215000
B=9000 units x $45	Variable cost $	405000
C=A+B	Contribution margin $	810000
D given	Fixed expenses $	540000
E=C-D	Net Income - Expected Profits $	270000

• Requirement 2: New plan

INCOME STATEMENT

	Units	per unit	Total Amount (in $)
Sales	[9000 units + 5000 units] 14000	135	1890000
Less: Variable cost	14000	[45+15] 60	840000
Contribution Margin	14000	75	1050000
Less: Fixed Cost
Fixed Cost (old)			540000
Fixed Cost (new Advertising)			150000
Total Fixed Cost			690000
New Net Income (Loss)			360000

Since, the Net Income is increasing along with Contribution margin, the company should adopt the new plan of incurring advertising expenditure and increasing variable cost.

• Requirement 3: Break Even point and Margin of Safety Percentage

A (calculated above)	Total fixed Cost	$690000
B (calculated above)	New contribution margin per unit	$75
C=A/B	Break Even units	9200
D (calculated above)	Total sold units	14000
E=C/D	Break Even %	65.71%
F=D-C	Margin of Safety Units	4800
G=F/D	Margin of Safety %	34.29%