Question

CVP Analysis and Special Decisions Sweet Grove Citrus Company buys a variety of citrus fruit from growers and then processes the fruit into a product line of fresh fruit, juices, and fruit flavorings. The most recent year's sales revenue was $4,200,000. Variable costs were 60 percent of sales and fixed costs totaled $1,200,000. Sweet Grove is evaluating two alternatives designed to enhance profitability. One staff member has proposed that Sweet Grove purchase more automated processing equipment. This strategy would increase fixed costs by $200,000 but decrease variable costs to 54 percent of sales. Another staff member has suggested that Sweet Grove rely more on outsourcing for fruit processing. This would reduce fixed costs by $200,000 but increase variable costs to 65 percent of sales. Round your answers to the nearest whole number. (a) What is the current break-even point in sales dollars? $Answer 0 (b) Assuming an income tax rate of 39 percent, what dollar sales volume is currently required to obtain an after-tax profit of $500,000? $Answer 0 (c) In the absence of income taxes, at what sales volume will both alternatives (automation and outsourcing) provide the same profit? $Answer 0 (d) Briefly describe one strength and one weakness of both the automation and the outsourcing alternatives. Automation has less risk and a lower break-even point. Outsourcing has higher profits if sales increase. Automation has higher profits if sales increase and a lower break-even point. Outsourcing has less risk. Automation has higher profits if sales increase. Outsourcing has less risk and a lower break-even point. Automation has less risk. Outsourcing has higher profits if sales increase and a lower break-even point.

Answer 1

Solution:

(a) the current break-even point in sales dollars

Break Even Point in sales dollars = Total Fixed Cost / Contribution Margin Ratio

Contribution Margin = Sales 4200,000 – Variable Cost 4200,000*60%

= 4200,000 – 2520,000

= 1680,000

Contribution Margin Ratio = Contribution Margin 1680,000 / Sales 4200,000 x 100 = 40%

Break Even Point in sales dollars = Total Fixed Cost 1,200,000 / Contribution Margin Ratio 40% or 0.4

= $3,000,000

(b) Assuming an income tax rate of 39 percent, what dollar sales volume is currently required to obtain an after-tax profit of $500,000?

Required Profit after tax = $500,000

It means required profit before tax = Required Profit after / (1 – Tax Rate)

= $500,000 / (1 – 0.39)

= $819,672

Required Dollar Sales Volume to obtain an after tax profit of $500,000 or before tax profit of $819,672 = (Total Fixed Cost + Before Tax Profit Required) / Contribution Margin Ratio

= (1,200,000 + 819,672) / 0.4

= $5,049,180