Question

Problem 11-29 Margin of safety and operating leverage LO 11-6 Vernon Company is considering the addition of a new product to its cosmetics line. The company has three distinctly different options: a skin cream, a bath oil, or a hair coloring gel. Relevant information and budgeted annual income statements for each of the products follow. Relevant Information Skin Cream Bath Oil Color Gel Budgeted sales in units (a) 136,000 216,000 96,000 Expected sales price (b) $ 9 $ 7 $ 15 Variable costs per unit (c) $ 2 $ 4 $ 10 Income statements Sales revenue (a × b) $ 1,224,000 $ 1,512,000 $ 1,440,000 Variable costs (a × c) (272,000 ) (864,000 ) (960,000 ) Contribution margin 952,000 648,000 480,000 Fixed costs (777,000 ) (555,000 ) (160,000 ) Net income $ 175,000 $ 93,000 $ 320,000 Required: Determine the margin of safety as a percentage for each product. Prepare revised income statements for each product, assuming a 20 percent increase in the budgeted sales volume. For each product, determine the percentage change in net income that results from the 20 percent increase in sales. Assuming that management is pessimistic and risk averse, which product should the company add to its cosmetics line? Assuming that management is optimistic and risk aggressive, which product should the company add to its cosmetics line?

Answer 1

			Skin Cream	Bth Oil	Color Gel
Sales revenue			1224000	1512000	1440000
Less: Variable cost			272000	864000	960000
Contribution			952000	648000	480000
Less: Fixed cost			777000	555000	160000
Net Income			175000	93000	320000
CM Ratio			77.78%	42.86%	33.33%
(Cnontribution/Sales*100)
Margin of Safety in $			225000	217000	960000
(Income/CM ratio
Margin of Safety %			18.38%	14.35%	66.67%
Req b: Revisedd Income Statement:
			Skin Cream	Bth Oil	Color Gel
Sales revenue			1468800	1814400	1728000
Less: Variable cost			326400	1036800	1152000
Contribution			1142400	777600	576000
Less: Fixed cost			777000	555000	160000
Net Income			365400	222600	416000
Increase in Income			190400	129600	96000
% increase in Income			108.80%	139.35%	30%
Req c:
When the management is pessimistic,
Product Color Gel is selected as it gives highest cushion as MOS is highest.
Req d:
when Management is optimistic, i.e. ready to take risk, it will concentrate on product having high operating leverage
Which is highest in Bath Oil
bath oil is selected.