Question

I'm stuck on questions 1-6, any thoughts?

Key Concepts

• Break Even = Incremental Expenses on Income Statement/Contribution Margin %
• Expenses are items that show up on the Income Statement or Profit/Loss
• Inventory by itself is not an expense. Inventory is an asset and shows up on the balance sheet.
• Inventory Expense for Full Lot Inventory Profile = Inventory * Inventory Carrying Cost % * Days/365
• Fixed Overhead is not an incremental expense on the Income Statement. It is “Fixed”. You do not factor “Fixed Overhead” into this analysis unless you need to increase your Overhead to increase the service level.

Business Situation

You are the Manager of a business. It could be a retailer, distributor or manufacturer. You are contemplating increasing customer service from 95% to 98% for your business to better service your customers needs. This means, you will have the product available 98-percent of the time when a customer wants to purchase it. The following are estimated to happen in your business:

Assumptions:

Sales are currently $80,000,000

Labor would increase $34,000

Direct materials (one-time increase) $40,000

Transportation would increase $60,000

Rent would increase $18,000 to accommodate the additional space to store the inventory

Inventory would increase by $3,000,000

Fixed overhead is $100,000 and does not need to be increased above its current level.

Inventory carrying cost = 25%

Contribution Margin on the product = 30%

You will make the inventory permanent, meaning it will be stored for 365-days

Questions (You must show work to receive credit or partial credit).

1. What expenses would you incur on the Income Statement to increase the service level from 95% to 98%. (list and/or calculate expenses for Income Statement)

2. What will be the change to the Balance Sheet (your answer must be quantified)?

3. What is the Break Even Point in dollars?

4. What amount must sales be increased to for this to be a good decision?

5. If sales are projected to increase by 2%, would you spend the money to increase service levels? Why or why not? You must justify your answer with quantified analysis.

6. If sales are projected to increase 8%, would you spend the money to increase service levels? Why or why not? You must justify your answer with quantified analysis.

Answer 1

Q-What expenses would you incur on the Income Statement to increase the service level from 95% to 98%. (list and/or calculate expenses for Income Statement)

Ans: Labor Cost 34000

Marerial 40000

   Transportaion 60000

Rent 18000

Additional Inventory 3000

Inventory Carrying cost 750

Total incremental cost    155750

Note : Material required for Rs. 40000/- is not relavant as it is one time cost as the benifit over a long period

Q. What will be the change to the Balance Sheet (your answer must be quantified)?

Ans: An increase in Inventory Rs. 3000/- (Current Asset)

Due to changes in Sales and cost the Profit also change under Reserves and Surplus   

Q .What is the Break Even Point in dollars?

Ans: BEP= Incremental exp/Contribution Margin

=155750/.30

=USD 519167

Q. What amount must sales be increased to for this to be a good decision?

Ans: BEP SALES =Fixed expenses ÷ Contribution margin percentage

=100000/.3

=333333

Additional sales req =333333-80000

=253333