Question

CVP Analysis at Molly’s Cupcakes[1] (B)

Recall Molly’s information

                     Revenue                $34,000

               -    Expense                   37,100

                     Profit (loss)           <$3,100>

Management responded with the following information

Costs have been matched to revenue to determine what costs should appear as expenses.

The costs of goods remaining in inventory are not included in expenses.

There are no fixed manufacturing costs.

Cost of sales is 40% of revenue.

$8,500 of the selling and administrative expenses are variable.

Costs and selling prices are expected to remain stable for at least the next two years.

Based on this information you created the following contribution margin format income statement and used it to analyze several alternatives for management.   

                                                                   % of

                                                           Revenue

Revenue                        34,000                      

Variable COGS             13,600         40.00%

Variable S&A                  8,500         25.00%

CM                                  11,900         35.00%

Fixed Cost                     15,000         44.12%

Profit                              -3,100          -9.12%              

Management is now wondering how sales mix will affect their financial picture. It provided the following information.

The current sales mix, computed as percent of total units, is 80% regular cupcakes and 20% deluxe cupcakes. The total number of cupcakes currently being sold is 10,000.

Regular cupcakes sell for $3.00 and have a contribution margin of $0.95 per unit.

Deluxe cupcakes sell for $5.00 and have a contribution margin of $2.15 per unit.

Management believes it can increase sales of deluxe cupcakes by rearranging the display case. Its best estimate is that deluxe cupcakes would increase to 48% of cupcakes sold.

It believes it will continue to have the same number of customers and sell the same number of cupcakes.

Part One:

Prepare a contribution format income statement with columns for each product line. Include a total company column as well. Do not give a break-out for fixed costs per product line. Instead, just put the total for fixed cost in the total company column.

Compute the current weighted average contribution margin per unit.

Compute the new weighted average contribution margin per unit that management expects will result from rearranging the display case.

Compute the amount of profit that Molly’s would generate if rearranging the display case was successful (that is, if it achieved the predicted results). Explain how Molly’s Cupcakes was able to be profitable even though it is still only selling 10,000 cupcakes in total.

Assume that Molly’s is currently paying its sales staff a $0.25 per cupcake selling commission (variable selling expense). Does this encourage the staff to sell the high margin cupcakes? Explain.

Briefly describe a better way to pay commissions to your sales staff that aligns with overall company profitability.

Using the new weighted average contribution margin you computed in question 3, compute the number of cupcakes that Molly’s must sell in order to generate a target profit of $3,000. How many of these cupcakes will be deluxe cupcakes?

Part Two:

Assume that Molly’s implements the display case strategy that results in the revised sales mix and increased profitability. For long-run profitability, management is also considering purchasing a new machine that will mix, bake and frost the cupcakes, considerably reducing the amount of direct labor needed. If the machine is purchased, depreciation expense will increase by $10,000 for the period and direct labor costs will decrease by $.60 per cupcake for regular cupcakes and $.80 for deluxe cupcakes.

Prepare a new contribution formatted income statement assuming Molly’s implements the display case strategy and sales volume grows to 15,000 cupcakes (Scenario 1). What is the new net operating income?

Prepare a new contribution formatted income statement assuming Molly’s purchases the new machine and implements the new sales display strategy. Assume sales volume grows to 15,000 cupcakes (Scenario 2). What is the new net operating income?

Now we are going to look at operating risk. Calculate the BEP in sales dollars, Margin of Safety Percentage, Operating Leverage and Profit sensitivity for each scenario.

Evaluate the risk of Scenario One versus Scenario Two. Which scenario inherently has more risk?

Using the profit sensitivity multiplier, determine the change in profit under both scenarios if sales go up by 30%? Down by 30%?

Using your results from question 5, what conclusion can you make about the most favorable operating structure for Molly’s? Hint: calculate the sales volume where profit is equal under both operating structures.

Answer 1

		INCOME STATEMENT
			Regular	Delux
			Cupcake	Cupcake	TOTAL
	A	Unit sales	8000	2000	10000
	B	Revenue per unit	$3	$5
	C=A*B	Total Revenue	$24,000	$10,000	$34,000
	D=B-F	Variable Costs per unit	$2.05	$2.85
	E=D*A	Total Variable costs	$16,400	$5,700	$22,100
	F	Contribution margin per unit	$0.95	$2.15
	G=F*A	Total contribution margin	$7,600	$4,300	$11,900
	H	Fixed Costs			$15,000
	I=G-H	Profit			($3,100)
		Current weighted average Contribution Margin prt unit			$       1.19	(0.8*0.95+0.2*2.15)
		Weight of Delux Cupcake=48%=0.48(As per new sales mix)
		Weight of Regular Cupcake=1-0.48=0.52(As per new sales mix)
		New weighted average Contribution Margin per unit			$    1.526	(0.52*0.95+0.48*2.15)
		COMPUTATION OF PROFIT AS PER NEW SALES MIX
			Regular	Delux
			Cupcake	Cupcake	TOTAL
	A	Unit sales	5200	4800	10000
	B	Revenue per unit	$3	$5
	C=A*B	Total Revenue	$15,600	$24,000	$39,600
	D=B-F	Variable Costs per unit	$2.05	$2.85
	E=D*A	Total Variable costs	$10,660	$13,680	$24,340
	F	Contribution margin per unit	$0.95	$2.15
	G=F*A	Total contribution margin	$4,940	$10,320	$15,260
	H	Fixed Costs			$15,000
	I=G-H	Profit			$260
		It has become profitable because weighted average contribution per unit has increased
		This has increased total contribution margin to $15,260 with same number of sales
		No, ot does not encourage sales staff to sell high margin cakes.The sales staff get same
		amount of commission of$0.25 whether he sells regular or delux cup cake
		Better way to pay commission should be percentage of revenue. The will encourage
		Sales staff to sell Delux cake which has higher revenue per unit
		Target profit	$3,000
		Required contribution margin	$18,000	(15000+3000)
		Weighted average contribution margin per unit	$1.526
		Required unit sales	11795.5439	(18000/1.526)
		Required unit sales(Rounded)	11796	numbers
		Required unit sales of delux cup cake	5662	numbers	(0.48*11796)