Question

Bubba’s Western Wear is a western hat retailer in Lubbock, Texas. Although Bubba’s carries numerous styles of western hats, each hat has approximately the same price and invoice (purchase) cost, as shown in the following table. Sales personnel receive a commission to encourage them to be more aggressive in their sales efforts. Currently, the Lubbock economy is really humming, and sales growth at Bubba’s has been great. The business is very competitive, however, and Bubba, the owner, has relied on his knowledgeable and courteous staff to attract and retain customers who otherwise might go to other western wear stores. Because of the rapid growth in sales, Bubba is also finding the management of certain aspects of the business more difficult, such as restocking inventory and hiring and training new salespeople.

Sales price	$	80.00
Per unit variable expenses
Purchase cost		41.50
Sales commissions		13.50
Total per unit variable costs	$	55.00
Total annual fixed expenses
Advertising	$	117,500
Rent		158,000
Salaries		264,250
Total fixed expenses	$	539,750

Required:

1. Calculate the annual breakeven point, both in terms of units and in terms of sales dollars.

2. If Bubba’s sells 22,000 hats, what is its before-tax income or loss? Support your answer by preparing a contribution income statement.

3. If Bubba’s sells 34,000 hats, what is its margin of safety (MOS) in dollars and MOS ratio?

4. Bubba is considering the elimination of sales commissions completely and increasing salaries by $172,500 annually. What would be the new breakeven point in units? What would be the before-tax income or loss if 22,000 hats are sold with the new salary plan?

Answer 1

		Sales Price	80
		Less: Variable Costs	55
		Contribution Margin	25
		Fixed Costs:
		Advertising	1,17,500
		Rent	1,58,000
		Salaries	2,64,250
		Total Fixed Costs	5,39,750
		Break Even Point:
		Total Fixed Costs	5,39,750
		Contribution Margin	25
		Break Even Point	21,590	Units
		Break Even Point in Units	21,590
		Sales Price	80
		Break Even Point in Value	17,27,200
	2	Sales	17,60,000
		Less: Variable Cost	12,10,000
		Contribution Margin	5,50,000
		Less: Fixed Costs	5,39,750
		Net Income	10,250
	3	Margin of Safety:
		Current Sales	27,20,000	(34000*80
		Less: Break Even Sales	17,27,200
		Margin of Safety	9,92,800
		Margin of Safety Ratio:
		Margin of Safety	9,92,800
		Current Sales	27,20,000
		Margin of Safety Ratio	0.365
	4	Original Fixed Cost	5,39,750
		Add: New Salaries	1,72,500
		Total New Fixed Costs	7,12,250
		Contribution Margin	38.5	(25+13.50)
		Break Even Units	18,500
		Contribution Margin	8,47,000
		Less: Fixed Costs	7,12,250
		Net Income	1,34,750
		Change in Income	1,24,500	(134750-10250)