Question

Problem 1

SG operates a booth at a local mall, selling watches. Current monthly sales revenue is $24,000 with total variable costs (wholesale cost of watches) of $9,000. SG currently pays $2,000 a month to rent the space and pays two full-time employees to each work 160 hours a month at $15 per hour. The manager is paid a monthly salary of $4,000.

Required (Show your work):

1. Calculate how much sales revenue SG needs to break even (10 points)
2. If SG wants to earn an operating income of $6,300 per month, then how much sales revenue does it need to generate? (5 points)
3. Calculate operating income if SG achieves sales revenue of $30,000. (5 points)
4. Assume SG can choose to pay rent at a rate of 10 percent of revenue. Note that this option would lower the CM ratio by 0.10 and lower fixed costs by $2,000 per month. SG can choose to pay rent either 1) as 10% of its revenue, or 2) as a monthly payment of $2,000. At what sales levels would SG prefer to pay a fixed amount of monthly rent (i.e., $2,000 per month), and at what sales levels would SG prefer to pay 10% of its monthly revenue as rent? (5 points)

Answer 1

Sales Revenue - $24,000

Variable expenses - $9,000

Fixed cost exepense = Rent + Emplyees wage + Salary of manager

2,000 + (2x160x15) + 4,000 = $10,800

Contribution = Sales - Variable cost

24,000 - 9,000 = $15,000

Contribution margin ratio = Contribution / sales

15,000/24,000 = 62.5%

Sales to Break even :

Break even in sales = Fixed Cost / Contribution margin ratio

10,800/62.5% = $17,280

Sales with a target income of $6,300

Sales with a target income = (Fixed cost + target income) / Contribution margin ratio

(10,800 + 6300) / 62,5% = $27,360

Operating income when sales revenue is $30,000

Since sales and contribution moves in the same proportion, the contribution margin ratio will remain the same as above. So using the above formula we can solve for x

Sales with a target income = (Fixed cost + target income) / Contribution margin ratio

Here, target income is taken as x.

30,000 = (10,800 + x) / 62.5%

30,000 x 62.5% = 10,800 + x

18,750 - 10,800 = x

x = 7,950

Thus operating income gained is $7,950 when sales revenue is $30,000.

Contribution margin ratio is reduced by .10 or 10% which gives us 52.5%

Fixed cost reduced by $2000 which gives us $8,800

Sales level at which monthly payment of rent is prefered.

Break even in sales = Fixed Cost / Contribution margin ratio

(8800 + 2000) / 52.5% = $20,571

Sales level at which 10% of revenue is prefered as rent.

Break even in sales = Fixed Cost / Contribution margin ratio

[8,800 + (10% x 24,000)] / 52.5% = $21,333