Question

Mary Willis is the advertising manager for Bargain 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 $36,000 in fixed costs to the $272,000 currently spent. In addition, Mary is proposing that a 5% price decrease ($40 to $38) will produce a 20% increase in sales volume (20,000 to 24,000). Variable costs will remain at $24 per pair of shoes. Management is impressed with Mary’s ideas but concerned about the effects that these changes will have on the break-even point and the margin of safety.

Compute the current break-even point in units, and compare it to the break-even point in units if Mary’s ideas are used. (Round answers to 0 decimal places, e.g. 1,225.)

Current break-even point			pairs of shoes
New break-even point			pairs of shoes

Prepare a CVP income statement for current operations and after Mary’s changes are introduced.

BARGAIN SHOE STORE CVP Income Statement
		Current		New
Administrative ExpensesContribution MarginCost of Goods SoldFixed ExpensesGross ProfitNet Income/(Loss)SalesSelling ExpensesVariable Expenses		$		$
Administrative ExpensesContribution MarginCost of Goods SoldFixed ExpensesGross ProfitNet Income/(Loss)SalesSelling ExpensesVariable Expenses
Administrative ExpensesContribution MarginCost of Goods SoldFixed ExpensesGross ProfitNet Income/(Loss)SalesSelling ExpensesVariable Expenses
Administrative ExpensesContribution MarginCost of Goods SoldFixed ExpensesGross ProfitNet Income/(Loss)SalesSelling ExpensesVariable Expenses
Administrative ExpensesContribution MarginCost of Goods SoldFixed ExpensesGross ProfitNet Income/(Loss)SalesSelling ExpensesVariable Expenses		$		$

Would you make the changes suggested?

NoYes

Answer 1

1. According to the question, first we need to calculate Break even point for both Current and New pair of shoes:

Formula for calculating Break even point is= Fixed cost/ Contribution margin per pair shoe

**Contribution margin is calculated by using formula= Selling price-Variable cost per unit

(i) Current year Break even point:-   

Fixed cost= $272,000 (Given)

Contribution margin= $40-$24= $16

Current Break even point in pair of shoes is= $272,000/16= 17,000

(ii) New Break Even point:-

New fixed cost= $36,000+ $272,000 =$308,000

Contribution margin=  $38- $24= $14

New Break even point in pair of shoes is =$308,000/ $14= $22,000

2. Next, we need to prepare CVP Income Statement for Current operations and New operations:

BARGAIN SHOE STORE CVP Income Statement
Particulars	Current (20,000 units) ($)	New(24,000 units) ($)
Sales (wn.1)-	800,000	912,000
Less: Variable Expenses(wn.2)	(480,000)	(576,000)
Contribution Margin	320,000	336,000
Less: Fixed Cost	(272,000)	(308,000)
Net Income-	48,000	28,000
The Net Income in current operations is more than in the proposed one by $20,000. Hence, it would not be suggested to to make the changes. We will not suggest it.

*Note: Negative items is represented or indicated in Brackets.

Working Notes:

1. Calculation of sales for current operations= 20,000 units *$40 per unit= $800,000

Sales for new one= 24,000 units * $38 per unit= $912,000

2. Calculation of Variable Expenses for Current operations= 20,000 units* $24 =$480,000

Variable Expenses for new one= 24,000 units* $24= $576,000