Question

Citrus company buys a variety of citrus fruit from growers and then processes the fruit into a product line. of fresh fruit, juices, and fruit flavorings.

Current annual sales revenue $2,000,000

Current Variable costs 35% of sales

Current Fixed costs totaled $600,000

Sweet Grove is evaluating 2 independent strategies designed to enhance profitability. You need to refer to the original data above to evaluate these two independent strategies.

Strategy #1. This strategy is to purchase more automated process equipment. This strategy would increase fixed costs by $100,000. This strategy would decrease variable costs to 25% of sales

Strategy #2. This strategy is to outsource the fruit processing. This strategy would reduce fixed costs by $125,000 This strategy would increase variable costs to 40% of sales

1. What is the current contribution margin ratio?

2. What is the current break-even point in sales dollars?

3. Determine the margin of safety in sales dollars.

4. Prepare a Contribution margin income statement for the current sales. Sales Less Variable Cost Contribution Margin Less Fixed Cost Profit

5. Compute the degree of operating leverage

6. If sales can increase by 10% of current sales level, what would be the percentage increase in profit?

7. Prepare a Contribution Margin income statement if sales increase 10% above current sales level. Sales Less Variable Cost Contribution Margin Less Fixed Cost Profit

8. Proof the change in profit if there is an increase of 10% of sales revenue compared to the original profit.

9. What is the break-even point in sales dollars for strategy #1?

10. What is the break-even point in sales dollars for strategy #2?

11. Describe one strength and one weakness of both the automation and the outsourcing alternatives. Recommend to management which strategy you would recommend and why?

Answer 1

1	Current contribution margin ratio=Contribution margin/Sales revenue
	Contribution margin=Sales revenue*(100%-variable cost %)=2000000*(100%-35%)=2000000*65%=$ 1300000
	Current contribution margin ratio=1300000/2000000=0.65
2	Current break-even point in sales dollars=Fixed cost/Contribution margin ratio=600000/0.6=$ 923077
3	Margin of safety in $=Sales revenue-Break-even point in sales dollars=2000000-923077=$ 1076923
4	Contribution margin income statement:
					$
	Sales				2000000
	Less: Variable cost		(2000000*35%)		700000
	Contribution Margin				1300000
	Less :Fixed Cost				600000
	Profit				700000
5	Degree of operating leverage=Contribution margin/Profit=1300000/700000=1.86
6	Increase in profit=Increase in sales*Degree of operating leverage=10%*1.86=18.6%
7	Contribution margin income statement:
					$
	Sales		(2000000*110%)		2200000
	Less: Variable cost		(2200000*35%)		770000
	Contribution Margin				1430000
	Less :Fixed Cost				600000
	Profit				830000
8	Increase in profit=830000-700000=$ 130000
	% increase=130000/700000=18.6%
	It is same with answer 6
9	break-even point in sales dollars=Fixed cost/Contribution margin ratio
	Fixed cost=600000+100000=$ 700000
	Contribution margin ratio=Contribution margin/Sales revenue
	Contribution margin=Sales revenue*(100%-variable cost %)=2000000*(100%-25%)=2000000*75%=$ 1500000
	Current contribution margin ratio=1500000/2000000=0.75
	break-even point in sales dollars=700000/0.75=$ 933333
10	break-even point in sales dollars=Fixed cost/Contribution margin ratio
	Fixed cost=600000-125000=$ 475000
	Contribution margin ratio=Contribution margin/Sales revenue
	Contribution margin=Sales revenue*(100%-variable cost %)=2000000*(100%-40%)=2000000*60%=$ 1200000
	Current contribution margin ratio=1200000/2000000=0.60
	break-even point in sales dollars=475000/0.60=$ 791667