Question

Situation for Analysis: Grayslake Novelty produces and sells a small novelty item through tourist shops in Chicago and other northern Illinois locations. Last year the company sold 198,400 units. The income statement for Grayslake Novelty for last year is shown below:

Sales	$992,000
Less: Variable Expenses	545,600
Contribution Margin	446,400
Less: Fixed Costs	180,000
Net Operating Income	$266,400

While the company has been profitable, as shown in the above income statement, sales began falling near the end of last year and have continued to decline this year. There is concern that new competitors are beginning to take market share from Grayslake Novelty. As a result, Sarah Burroughs, the company president, has asked you to provide some information to assist her in making decisions about the company’s strategy for this product. These alternatives should be evaluated individually as stated. You are free to offer your own alternative based on any of the parameters given in the data.

Required:

a. While the company is currently profitable, the president wants to know the contribution margin and the breakeven in both units and dollars using last year’s level of sales. Additionally, compute the margin of safety, margin of safety ratio, and degree of operating leverage based on last year’s sales.

b. One of the possible strategies (Alt 1) is to reduce the current price by 8%. Using last year’s level of sales, what is the new contribution margin and break-even in units and dollars based on the price reduction? Additionally, compute the margin of safety, margin of safety ratio, and degree of operating leverage based on last year’s sales.

c. A second strategy (Alt 2) is to reduce the current variable cost by 0.20 per unit. The company has identified available efficiencies that can be implemented without any additional changes to the current cost. What is the new contribution margin and break-even in units and dollars based on the variable cost reduction of 0.20 per unit? Additionally, compute the margin of safety, margin of safety ratio, and degree of operating leverage based on last year’s sales.

d. A third strategy (Alt3) is to decrease the current price by 8% and reduce the variable cost per unit by 0.20. What is the new contribution margin and break-even in units and dollars based on making both changes? Additionally, compute the margin of safety, margin of safety ratio, and degree of operating leverage based on last year’s sales.

e. A fourth strategy (Alt 4) under consideration is to invest in more automated equipment for the manufacturing process. This investment will reduce variable costs by 0.65 per unit, primarily reducing the direct labor. At the same time, this will increase the fixed costs by $50,000. What is the new contribution margin and break-even in units and dollars based on this change in operating structure? Additionally, compute the margin of safety, margin of safety ratio, and degree of operating leverage based on last year’s sales.

f. A final strategy (Alt 5) is to change the current structure for the company’s sales person. The current fixed cost includes the salary of Grayslake’s one sales person at $60,000 per year. The company’s marketing study suggests that sales could be increased by 20% if the company hired an additional sales person; paid both individuals $40,000 fixed salaries; and a 0.25 commission per unit sold. What is the new contribution margin and break-even in units and dollars based on this change? Additionally, compute the margin of safety, margin of safety ratio, and degree of operating leverage based on last year’s sales as the starting point for this change.

Submission Instructions:

Write a business memo (format is in the second document of this assignment) addressed to the president recommending the best course of action based on your analysis. In your memo, discuss changes in break-even points, and impacts to the operating leverage. Including a table summarizing your findings would be appropriate. The company’s long-range plan is to grow sales to 250,000 units in the next two to three years. In your memo, summarize the advantages and disadvantages of each of the alternatives. Critically evaluate the alternatives based on current market conditions and any impact each alternative may have on the long-range plan.

Clearly state your recommended course of action explaining why your recommendation is the best for the company. Your memo should be at least one page, but no longer than two full pages. You may also attach an Excel spreadsheet that shows all your calculations or you may embed your computations into the memo using tables. The calculations supporting your data and analysis must be included.

Answer 1

working		per unit
No. of units		198400
Sales	$992,000	$5
Less: Variable Expenses	545,600	2.75
Contribution Margin	446,400	2
Less: Fixed Costs	180,000
Net Operating Income	$266,400
CM ratio 2/5*100		45	%
Ans a
Sales	$992,000
Less: Variable Expenses	545,600
Contribution Margin	446,400
Less: Fixed Costs	180,000
Net Operating Income	$266,400
Contribution Margin	446,400
Breakeven in units
Fixed cost/CM	80000	units
180000/2
In $	400000
180000/45%
Margin of safety in units
198400-90000	118400
Margin of safety ratio
198400-90000/198400	0.60
	55%
Degree of operating leverage
CM/Net operating Income	1.68
446400/266400
Ans b
working
working		per unit
No. of units		198400
Sales	$912,640	$4.60
Less: Variable Expenses	545,600	2.75
Contribution Margin	367,040	1.85
Less: Fixed Costs	180,000
Net Operating Income	$187,040
CM ratio 1.85/5*100		40	%
Sales	$912,640
Less: Variable Expenses	545,600
Contribution Margin	367,040
Less: Fixed Costs	180,000
Net Operating Income	$187,040
Contribution Margin	367,040
Breakeven in units
Fixed cost/CM	97297	units
180000/1.85
In $	447568
180000/40%
Margin of safety in units
198400-97297	101103
Margin of safety ratio
198400-97297/198400	0.51
	51%
Degree of operating leverage
CM/Net operating Income	1.96
367040/187040
ANS C
working		per unit
No. of units		198400
Sales	$992,000	$5.00
Less: Variable Expenses	446,400	2.25
Contribution Margin	545,600	2.75
Less: Fixed Costs	180,000
Net Operating Income	$365,600
CM ratio 1.85/5*100		55	%
Sales	$992,000
Less: Variable Expenses	446,400
Contribution Margin	545,600
Less: Fixed Costs	180,000
Net Operating Income	$365,600
Contribution Margin	545,600
Breakeven in units
Fixed cost/CM	65455	units
180000/2.75
In $	327273
180000/55%
Margin of safety in units
198400-65455	132945
Margin of safety ratio
198400-65455/198400	0.67
	51%
Degree of operating leverage
CM/Net operating Income	1.49
545600/266400
ans d
working		per unit
No. of units		198400
Sales	$912,640	$4.60
Less: Variable Expenses	446,400	2.25
Contribution Margin	466,240	2.35
Less: Fixed Costs	180,000
Net Operating Income	$286,240
CM ratio 2.35/5*100		51	%
Sales	$912,640
Less: Variable Expenses	446,400
Contribution Margin	466,240
Less: Fixed Costs	180,000
Net Operating Income	$286,240
Contribution Margin	466,240
Breakeven in units
Fixed cost/CM	76596	units
180000/2.35
In $	352340
180000/51%
Margin of safety in units
198400-76596	121804
Margin of safety ratio
198400-76596/198400	0.61
	61%
Degree of operating leverage
CM/Net operating Income	1.63
466240/286240
Dear student I have done first four subparts