Question

1. Capstone, Inc. markets a simple water control and timer that it mass-produces. During 2019, the company sold 650,000 units at an average selling price of per solution $10.00 per unit. The variable expenses were $1,825,000, and the fixed expenses were $797,500.
   1. What is the product’s contribution margin ratio? (Round to nearest whole percentage)
   2. What is the company’s break-even point in units and in dollars for this product?
   3. What is the margin of safety, both in dollars and as a ratio? (Round to nearest whole percentage)
   4. If management wanted to increase its income from this product by 10%, how many additional units would have to be sold to reach this income level?
   5. If sales increase by 35,000 units and the cost behaviors do not change, how much will income increase on this product?

2. Capstone, Inc. is thinking of mass-producing one of its special-order sprinklers. To do so would increase variable costs for all sprinklers by an average of $0.50 per unit. The company also estimates that this change could increase the overall number of sprinklers sold by 10%, and the average sales price would increase $0.35 per unit. Capstone, Inc. currently sells 525,000 sprinkler units at an average selling price of $35.00. The manufacturing costs are $6,850,000 variable and $2,050,140 fixed. Selling and administrative costs are $2,651,657 variable and $885,000 fixed.
   1. If Capstone, Inc. begins mass-producing its special-order sprinklers, how would this affect the company?
   2. If the average sales price per sprinkler unit did not increase when the company began mass-producing the special-order sprinkler, what would be the effect on the company?

Answer 1

a.	Contribution margin ratio=Contribution margin per unit/Unit selling price
	Contribution margin per unit=Unit selling price-Unit variable expenses
	Unit variable expenses=Total variable expenses/Units sold=1825000/650000=$ 2.81
	Contribution margin per unit=10-2.81=$ 7.19
	Contribution margin ratio=7.19/10=0.719=0.72=72%
	Break-even point in units=Fixed expenses/Contribution margin per unit=797500/7.19=110918
	Break-even point in dollars=Fixed expenses/Contribution margin ratio=797500/72%=$ 1107639
	Margin of safety in dollars=Actual sales in dollars-Break even point in dollars=(650000*10)-1107639=$ 5392361
	Margin of safety as a ratio=Margin of safety in dollars/Actual sales in dollars=5392361/6500000=0.8296=83%
	Current net income=Total contribution margin-Fixed expenses
	Total contribution margin=Units sold*Contribution margin per unit=650000*7.19=$ 4673500
	Current net income=4673500-797500=$ 3876000
	Increase in net income by 10%.
	Desired net income=3876000*110%=$ 4263600
	Units to be sold to achieve desired income=(Fixed expenses+Desired income)/Contribution margin per unit=(797500+4263600)/7.19=703909
	Additional units to be sold=703909-650000=53909 units
	New net income=Total contribution margin-Fixed expenses
	Total contribution margin=Units sold*Contribution margin per unit=(650000+35000)*7.19=$ 4925150
	New net income=4925150-797500=$ 4127650
	Increase in net income=4127650-3876000=$ 251650
a.	Current situation:
	Variable expenses per unit=Total variable expenses/Units sold=(6850000+2651657)/525000=$ 18.10
	Net income:
						$
	Sales			(525000*35)		18375000
	Less: Variable expenses			(6850000+2651657)		9501657
	Contribution margin					8873343
	Less: Fixed expenses			(2050140+885000)		2935140
	Net income					5938203
	Contribution margin ratio=Total contribution margin/Sales=8873343/18375000=0.4829=48%
	Special order situation:
	New variable expenses per unit=18.10+0.50=$ 18.60
	New selling price per unit=35+0.35=$ 35.35
	Net income:
						$
	Sales			(525000*110%*35.35)		20414625
	Less: Variable expenses			(525000*110%*18.60)		10741500
	Contribution margin					9673125
	Less: Fixed expenses			(2050140+885000)		2935140
	Net income					6737985
	Contribution margin ratio=Total contribution margin/Sales=9673125/20414625=0.4738=47%
	Effect on the company
				Current	New	Effect
	Contribution margin ratio			48%	47%	Decrease by 1%
	Net income			5938203	6737985	Increase by $799782