Question

Problem 6.45A a-c

Alice Oritz is the advertising manager for Value Shoe Store. She is currently working on a major promotional campaign. Her ideas include the installation of a new lighting system and increased display space that will add $25,830 in fixed costs to the $262,605 currently spent. In addition, Alice is proposing that a 10% price decrease ($35 to $31.50) will produce a 20% increase in sales volume (20,500 to 24,600). Variable costs will remain at $14 per pair of shoes. Management are impressed with Alice’s ideas but are concerned about the effects that these changes will have on the break-even point and the margin of safety.

Calculate the current break-even point in units, and compare it with the break-even point in units if Alice’s ideas are used.

Current break-even point		units
Break-even point if Alice’s ideas are used		units

Calculate the margin of safety ratio for current operations and after Alice’s changes are introduced.

Current margin of safety ratio		%
Margin of safety ratio Alice’s changes are introduced		%

Prepare CVP income statements for current operations and after Alice’s changes are introduced.

Would you make the changes suggested?

The changes _____________ be made.

Answer 1

Ans:

1. Current Break-even Point= Fixed Costs/Contribution Margin

Current sales volume = 20,500

Current fixed costs = $262,605

Current selling price per pair of shoes = $35

Current variable cost per pair of shoes = $14

Proposed sales volume = 24,600

Proposed fixed costs = $288,435 {262,605+25,830}

Proposed selling price = $31.50 per pair of shoe

Proposed variable cost = $14 per pair of shoe

But, Contribution margin per unit = Selling price - Variable cost

                                                 = $35 - $14

                                                 = $21

Break-even point in units = $262,605 / $21

                                    = 12,505 units

Computing the Proposed break-even point in units:

Break-even point in units = Fixed costs / Contribution margin per unit

                                     = $288,435 / ($31.50 - $14)

                                     = $288,435 / $17.50

                                     = 16,482 units

B). Margin Of Safety= Actual Sales- Break even Sales/Break even Sales

Actual sales = Sales volume * Selling price per shoe pair

                  = 20,500 * $35

                  = $717,500

Break-even sales = Break-even point * Selling price

                         = 12,505 * $35

                         = $437,675

Margin of safety = ($717,500 - $437,675) / $437,675

                         = 279,825/437,675

=> 63.93%

For Proposed operations:

Actual sales = 24,600* $31.50

                  = $774,900

Break-even sales = 16,482 * $31.50

                         = $519,183

Margin of safety = ($774,900- $519,183) / $519,183

                         = 255,717/519,183

=> 49.25%

C). CVP statement

Income Statement	Current operations	Proposed Operations
Sales	717,500	774,900
Less: variable Costs	(287,000)	(344,400)
Contribution Margin	430,500	430,500
Fixed Costs	(262,605)	(288,435)
operating Income	167,895	142,065

Therefore net income was reduced by 25,830, therefore changes will not be implemented