Question

You are the advisor of a Junior Achievement group in a local high school. You need to help the group make a decision about fees that must be paid to sell gardening tools at the Home and Garden Show. The group sells a set of tools for $20.00. The manufacturing cost (all variable) is $6 per set. The Home and Garden Show coordinator allows the following three payment options for groups exhibiting and selling at the show:

1.Pay a fixed booth fee of $5,600.

2.Pay a fee of $3,800 plus 10% of all revenue from tool sets sold at the show.

3.Pay 15% of all revenue from tool sets sold at the show.

REQUIRED

A.  Compute the breakeven number of tool sets for each option.

B.  Which payment plan has the highest degree of operating leverage?

C.  Which payment plan has the lowest risk of loss for the organization? Explain.

D.  At what level of revenue should the group be indifferent to options 1 and 2?

E.  Which option should Junior Achievement choose, assuming that sales are expected to be 1,000 sets of tools? Explain.

Answer 1

Solution A:

Selling price of gardening tool = $20

Variable manufacturing cost = $ 6

Computation of breakeven point:

Option 1 : Fixed Cost = $5,600

Contribution = 20 - 6 = $14 per set

Hence break even point = Fixed cost / Contribution per unit = $5,600 / 14 = 400 tool set

Option 2:

Fixed Fee = $3,800

Variable fee for exhibition = 20*10% = $2 per set

Contribution = $20 - $6 - $2 = $12 per unit

Break even point = $3,800 / 12 = 317 tool set

Option 3:

Variable fee for exhibition = 20*15% = $3 per set

Fixed Fee = $0

Contribution per unit = $20 - $6 - $3 = $11 per tool set

Break even point = 0/11 = 0 tool set

Solution B:

Operating leverage = Contribution / Operating income

Operating income is calculated by subtracting fixed cost from contribution.

Therefore highest degree of operating leverage exist in that option which is having highest fixed cost. Therefore option 1 will have highest operating leverage as in this option fixed cost is highest at $5,600

Solution C:

The payment plan which is having lowest fixed cost have lowest rick of loss for the organiztion because in this case, if organization is not able to sell ample quantity of tool set it does not have any fixed obligation. Therefore option 3 payment plan will be considered as lowest risk of loss to the organization

Solution D:

Let at X unit level group will be indifferent under option 1 and 2.

Profit at X Unit under option 1 = 14X - 5600

Profit at X unit under option 2 = 12X - 3800

Therefore profit at X unit under option 1 = Profit at X unit under option 2

14X - 5600 = 12X - 3800

2X = 1800

X = 900 tool set

Revenue at 900 tool set = 900*20 = $18,000

Therefore at $18,000 revenue level group will be indifferent under option 1 & option 2.

Solution E:

Expected Sales = 1000 sets

Profit under option 1 = 1000*14 - 5600 = $8,400

Profit under option 2 = 1000*12 - 3800 = $8,200

Profit unde option 3 = 1000*11 = $11,000

Therefore junior acheivement should choose option 3 as it will give maximum profit.