Question

CVP:
Colourful Candy Ltd produces a brightly coloured range of large lollipops. Each lollipop
sells for $5.60. Variable unit costs are as follows:

Colouring Agents $0.70
Sugar $0.35
Corn Syrup $1.85
Other ingredients $0.34
Packaging $0.76
Lollipop Moulds and Sticks $0.20

Fixed overhead cost is $32,300 per year. Fixed selling and administrative costs are $12,500
per year. Colourful Candy sold 35,000 lollipops last year. The tax rate is 30%.
Required:
a) What is the contribution margin per unit for a lollipop? What is the contribution margin ratio?
b) How many lollipops must be sold to break even? What is break-even point in sales revenue?
c) How many units need to be sold to make an after-tax profit of $23,520?
d) What was Colourful’s operating income last year?
e) Suppose that Colourful increases the price to $6.20 per lollipop but anticipates a drop in sales of 3,500 units. What will be the new break-even point in units?
Colourful raise the price? Explain.

Answer 1

Answer:

(a) Calculation of Contribution per unit for a Lollipop

Contribution per unit = Sales - Variable costs

	Where,
		Selling price = $5.60
		Variable Cost= $4.2 ($0.70+$0.35+$1.85+$0.34+$0.76+$0.20)
		=	$5.60-$4.2
Contribution per unit =			$1.40

Calculation of contribution Margin ratio

Contribution Margin ratio = Contribution per unit / Selling price per unit

= ($1.40/$5.60)*100

= 25%

b) No Lollipops must be sold to Break-even = Fixed Cost/ Contribution per unit

= $44,800 ($32,300+$ 12,500)/$ 1.40 per Lollipop

= 32000 Lolipops

Break-even point in Sales = Fixed Cost/ PV Ratio

Where, PV Ratio = Contribution/ sales

= 25%

Break-even point in Sales = ($44800/25)*100

= $ 179,200

(c) Calculation of number of units must be sold to make after tax profit of $ 23,520

After tax income = $ 23,520  

Tax rate = 30%

desired level of profit before tax = ($ 23,520/70)*100

= $ 33,600

Estimate sales Level = (Fixed Cost + Desired profit)/ PV Ratio

= [($ 44.800 + $ 33,600)/25]*100

= $ 313,600

(Note: Students must note that, inorder to calculate estimated sales Before tax profit must be considered)

(e) When selling pice = $6.20 per unit

Reduction in sales = 3500 units

BEP (units) = Fixed Cost/ Contribution per unit

Where, contribution per unit = $ 6.20-$4.20

= $ 2 per unit

(BEP units) = $ 44,800/$2

New break even point in units = $ 22,400

(Note; Variable cost and fixed cost remain unchanged)

When the Colourful raised the selling price, there is a drammatic increase increase in contribution per unit as variable cost remain unchanged to some extend and it will lead to reduction in break-even point in units subject to reduction in sales volume.