Question

Terry Smith and two of his colleagues are considering opening a law office in a large metropolitan area that would make inexpensive legal services available to those who could not otherwise afford services. The intent is to provide easy access for their clients by having the office open 360 days per year, 16 hours each day from 7:00 a.m. to 11:00 p.m. The office would be staffed by a lawyer, paralegal, legal secretary, and clerk-receptionist for each of the two eight-hour shifts. In order to determine the feasibility of the project, Smith hired a marketing consultant to assist with market projections. The results of this study show that if the firm spends $1,025,000 on advertising the first year, the number of new clients expected each day will be 59. Smith and his associates believe this number is reasonable and are prepared to spend the $1,025,000 on advertising. Other pertinent information about the operation of the office follows: The only charge to each new client would be $69 for the initial consultation. All cases that warrant further legal work will be accepted on a contingency basis with the firm earning 30 percent of any favorable settlements or judgments. Smith estimates that 20 percent of new client consultations will result in favorable settlements or judgments averaging $4,900 each. It is not expected that there will be repeat clients during the first year of operations. The hourly wages of the staff are projected to be $59 for the lawyer, $49 for the paralegal, $39 for the legal secretary, and $29 for the clerk-receptionist. Fringe benefit expense will be 40 percent of the wages paid. A total of 580 hours of overtime is expected for the year; this will be divided equally between the legal secretary and the clerk-receptionist positions. Overtime will be paid at one and one-half times the regular wage, and the fringe benefit expense will apply to the full wage. Smith has located 6,000 square feet of suitable office space that rents for $65 per square foot annually. Associated expenses will be $58,500 for property insurance and $81,200 for utilities. It will be necessary for the group to purchase malpractice insurance, which is expected to cost $369,000 annually. The initial investment in the office equipment will be $129,000. This equipment has an estimated useful life of four years. The cost of office supplies has been estimated to be $10 per expected new client consultation. Required: Determine how many new clients must visit the law office being considered by Terry Smith and his colleagues in order for the venture to break even during its first year of operations. (Do not round intermediate calculations and round your final answer up to nearest whole number.) Compute the law firm’s safety margin.

Answer 1

Requirement 1: Compute break-even point for the venture as follows

Break-even point occurs when total revenue equals total cost and it can be expressed in the following equation

$0        = Revenues − Variable Cost − Fixed Cost

$0        = $69X + ($4,900 × 20%X × 30%) − $10X − $3,416,626

$0        = $69X + $294X − $10X − $3,416,626

353X    = $3,416,626

X          = 9,679 clients

9,679 new clients should visit the law office in order for the venture to break-even during the first year of operations.

Notes: Compute total fixed costs as follows

Particulars	Amount	Amount
Fixed costs
Advertising expenses		$1,025,000
Wages Expenses:
Regular wages: 360 days × 16 hours per day × ($59 + $49 + $39 + $29)	$1,013,760
Overtime wages: (290× hours $39 ×1.5) + (290 hours × $29 per hour × 1.5 times)	$29,580
Total wages	$1,043,340
Add: Fringe benefits @ 40% on $1,043,340	$417,336	$1,460,676
Rent expenses (6,000 square feet × $65 per square feet		$390,000
Property insurance expense		$58,500
Utilities expenses		$81,200
Insurance expenses		$369,000
Depreciation expense ($129,000 ÷ 4 years)		$32,250
Total fixed costs		$3,416,626

Requirement 2: Compute margin of safety as follows

Total expected new clients = 21,240 (59 new clients per day × 360 days)

Margin of safety         = Budgeted sales revenue − Break-even sales revenue

                                   = (($69 per client × 21,240) + ($4,900 × 21,240 × 20% × 30%)) − (($69 per client × 9,679) + ($4,900 × 9,679 × 20% × 30%))

                                    = ($69 + ($4,900 × 20% × 30%)) × (21,240 − 9,679)

                                    = $4,196,706