Question

In: Accounting

Vernon Company is considering the addition of a new product to its cosmetics line. The company...

Vernon Company is considering the addition of a new product to its cosmetics line. The company has three distinctly different options: a skin cream, a bath oil, or a hair coloring gel. Relevant information and budgeted annual income statements for each of the products follow.

Relevant Information
Skin Cream Bath Oil Color Gel
Budgeted sales in units (a) 136,000 216,000 96,000
Expected sales price (b) $ 9 $ 7 $ 15
Variable costs per unit (c) $ 2 $ 4 $ 10
Income statements
Sales revenue (a × b) $ 1,224,000 $ 1,512,000 $ 1,440,000
Variable costs (a × c) (272,000 ) (864,000 ) (960,000 )
Contribution margin 952,000 648,000 480,000
Fixed costs (777,000 ) (555,000 ) (160,000 )
Net income $ 175,000 $ 93,000 $ 320,000

  
Required:

  1. Determine the margin of safety as a percentage for each product.

  2. Prepare revised income statements for each product, assuming a 20 percent increase in the budgeted sales volume.

  3. For each product, determine the percentage change in net income that results from the 20 percent increase in sales.

  4. Assuming that management is pessimistic and risk-averse, which product should the company add to its cosmetics line?

  5. Assuming that management is optimistic and risk aggressive, which product should the company add to its cosmetics line?

Solutions

Expert Solution

a) Calculation of Margin of safety percentage is shown as follows:-   (Amounts in $)   

Skin Cream Bath Oil Color Gel
1) Fixed Costs 777,000 555,000 160,000
2) Expected Sales Price per unit 9 7 15
3) Variable Cost per unit 2 4 10
4) Contribution Per unit (2-3) 7 3 5
5) Break Even Point (in units) (1/4) 111,000 185,000 32,000
6) Current Budgeted Sales (in units) 136,000 216,000 96,000
7) Margin of Safety (in units) 25,000 31,000 64,000
8) Margin of safety Percentage [(7/6)*100] 18.38% 14.35% 66.67%

b) Revised Income statement after 20% increase in budgeted volume is shown as follows:-   

Skin Cream Bath Oil Color Gel
Budgeted sales in units (a) 136,000 216,000 96,000
Expected sales after 20% increase (b = a*1.2) 163,200 259,200 115,200
Expected sales price (c) $ 9 $ 7 $ 15
Variable costs per unit (d) $ 2 $ 4 $ 10
Income statements
Sales revenue (b × c) $ 1,468,800 $ 1,814,400 $ 1,728,000
Variable costs (b × d) (326,400) (1,036,800) (1,152,000)
Contribution margin 1,142,400 777,600 576,000
Fixed costs (777,000) (555,000) (160,000)
Net income $ 365,400 $ 222,600 $ 416,000

c) Calculation of percentage change in income after 20% increase in sales volume   

Skin Cream Bath Oil Color gel
1) Net Income before change $175,000 $93,000 $320,000
2) Net income after change $365,400 $222,600 $416,000
3) Percentage change [(2-1)*100] 108.80% 139.35% 30%

d) Firstly we need to rank all the three products on the basis of Margin of safety %, Net income after increase in sales volume and % increase in net income which is shown as follows:-

Skin Cream Bath Oil Color Gel
i) Margin of Safety % 18.38% 14.35% 66.67%
Ranking 2 3 1
ii) Net income after increase in sales volume $365,400 $222,600 $416,000
Ranking 2 1 3
iii) Percentage Increase in net income 108.80% 139.35% 30%
Ranking 2 1 3

Based on the above rankings, skin cream is the only product which is out of ranking 3. Therefore the company should add skin cream to its cosmetics line. (Assuming management is pessimistic and risk-averse).

e) Based on the above rankings, bath oil is the only product which is ranked at first position twice. Therefore the company should add bath oil to its cosmetics line. (Assuming management is optimistic and risk-aggressive).


Related Solutions

Zachary Company is considering the addition of a new product to its cosmetics line. The company...
Zachary Company is considering the addition of a new product to its cosmetics line. The company has three distinctly different options: a skin cream, a bath oil, or a hair coloring gel. Relevant information and budgeted annual income statements for each of the products follow. Relevant Information Skin Cream Bath Oil Color Gel Budgeted sales in units (a) 140,000 220,000 100,000 Expected sales price (b) $ 7 $ 7 $ 15 Variable costs per unit (c) $ 2 $ 4...
Walton Company is considering the addition of a new product to its cosmetics line. The company...
Walton Company is considering the addition of a new product to its cosmetics line. The company has three distinctly different options: a skin cream, a bath oil, or a hair coloring gel. Relevant information and budgeted annual income statements for each of the products follow. Relevant Information Skin Cream Bath Oil Color Gel Budgeted sales in units (a) 138,000 218,000 98,000 Expected sales price (b) $ 10 $ 9 $ 16 Variable costs per unit (c) $ 2 $ 4...
Zachary Company is considering the addition of a new product to its cosmetics line. The company...
Zachary Company is considering the addition of a new product to its cosmetics line. The company has three distinctly different options: a skin cream, a bath oil, or a hair coloring gel. Relevant information and budgeted annual income statements for each of the products follow. Relevant Information Skin Cream Bath Oil Color Gel Budgeted sales in units (a) 140,000 220,000 100,000 Expected sales price (b) $ 7 $ 7 $ 15 Variable costs per unit (c) $ 2 $ 4...
Solomon Company is considering the addition of a new product to its cosmetics line. The company...
Solomon Company is considering the addition of a new product to its cosmetics line. The company has three distinctly different options: a skin cream, a bath oil, or a hair coloring gel. Relevant information and budgeted annual income statements for each of the products follow. Relevant Information Skin Cream Bath Oil Color Gel Budgeted sales in units (a) 130,000 210,000 90,000 Expected sales price (b) $ 10 $ 9 $ 15 Variable costs per unit (c) $ 2 $ 4...
Baird Company is considering the addition of a new product to its cosmetics line. The company...
Baird Company is considering the addition of a new product to its cosmetics line. The company has three distinctly different options: a skin cream, a bath oil, or a hair coloring gel. Relevant information and budgeted annual income statements for each of the products follow. Relevant Information Skin Cream Bath Oil Color Gel Budgeted sales in units (a) 104,000 184,000 64,000 Expected sales price (b) $ 9 $ 4 $ 11 Variable costs per unit (c) $ 2 $ 1...
Rooney Company is considering the addition of a new product to its cosmetics line. The company...
Rooney Company is considering the addition of a new product to its cosmetics line. The company has three distinctly different options: a skin cream, a bath oil, or a hair coloring gel. Relevant information and budgeted annual income statements for each of the products follow. Relevant Information Skin Cream Bath Oil Color Gel Budgeted sales in units (a) 128,000 208,000 88,000 Expected sales price (b) $ 9 $ 7 $ 14 Variable costs per unit (c) $ 2 $ 4...
Rundle Company is considering the addition of a new product to its cosmetics line. The company...
Rundle Company is considering the addition of a new product to its cosmetics line. The company has three distinctly different options: a skin cream, a bath oil, or a hair coloring gel. Relevant information and budgeted annual income statements for each of the products follow. Relevant Information Skin Cream Bath Oil Color Gel Budgeted sales in units (a) 126,000 206,000 86,000 Expected sales price (b) $ 8 $ 6 $ 13 Variable costs per unit (c) $ 2 $ 4...
A Company is considering a new product line to supplement its range line. It is anticipated...
A Company is considering a new product line to supplement its range line. It is anticipated that the new product line will involve cash investment of $700,000 at time 0 and $1.0 million in year 1. After-tax cash inflows of $500,000 are expected in year 2, $300,000 in year 3, $700,000 in year 4, and $400,000 each year thereafter through year 10. Though the product line might be viable after year 10, the company prefers to be conservative and end...
Briarcliff Stove Company is considering a new product line to supplement its range line. It is...
Briarcliff Stove Company is considering a new product line to supplement its range line. It is anticipated that the new product line will involve cash investment of $700,000 at time 0 and $1.0 million in year 1. After tax cash inflows of $250,000 are expected in year 2, $300,000 in year 3, $350,000 in year 4, and $400,000 each year thereafter through year 6. Though the product line might be viable after year 6, the company prefers to be conservative...
Shrieves Casting Company is considering adding a new line to its product mix, and the company...
Shrieves Casting Company is considering adding a new line to its product mix, and the company hires you, a recently business school graduate, to conduct capital budgeting analysis. The production line would be set up in unused space in Shrieves' main plant. The machinery’s invoice price would be approximately $200,000; another $10,000 in shipping charges would be required; and it would cost an additional $30,000 to install the equipment. The machinery has an economic life of 4 years, and would...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT