Question

Ned's New Wave Barber Shop specializes in modern unisex haircuts. The only service available at Ned's is a “20-minute” haircut for which the customer is charged $10. The shop has five (5) barbers. (Ned does not work in the shop and, as owner/entrepreneur, he takes no salary.) Each barber is paid an annual salary of $18,000. All equipment including store fixtures and barbering equipment is leased on an annual basis at $4,500 per year. Building space is leased at the rate of $500 per month (or $6,000 per year). Ned is concerned about the shop’s cost structure and seeks your advice.

1. Compute the contribution margin per haircut.

2. Compute the annual break-even point in number of haircuts.

3. Compute the profit or loss at three different volumes of output: a. Last year, Ned's performed 15,000 haircuts. What was the total profit or loss? What was the profit or loss per haircut? b. What would total profit and profit per haircut have been at 10% higher volume, i.e., 16,500 haircuts? c. What would total profit and profit per haircut have been at 10% lower volume, i.e., 13,500 haircuts?

4. Ned is considering the following changes to how he pays the barbers and the landlord. a. Change only how barbers are paid. Instead of receiving a salary, barbers would receive a commission equal to 50% of the selling price of each haircut. What is the new contribution margin per haircut? What is the new annual break-even point in number of haircuts? b. Change only the building lease agreement so that the landlord receives monthly rent of $100 plus 10% of the revenue per haircut. What is the new contribution margin per haircut? What is the new annual break-even point in number ofhaircuts? c. Change both the compensation system for the barbers and the building lease agreement. If both are changed, what is the new contribution margin per haircut? What is the new annual break-even point in number of haircuts?

5. Evaluate the four cost structures proposed above, i.e., the original cost structure and the three changes in question Which cost structure would you recommend and why? Explain how your recommendation depends on your assumptions. For example: a. Do you think Ned will be able to implement the changes outlined in question 4? Will the barbers agree to work on commission? Will the landlord agree to accept less fixed rent in exchange for a share of revenue? b. Do you expect the number of haircuts sold to differ across the four cost structures? If so, what differences would you expect? c. What are the differences in risk to Ned across the four cost structures?

Answer 1

As per policy, only four parts of a question are allowed to answer at a time, so answering four parts and sub parts here:

1)

Variable expense = $0

Service charge per haircut = $10

Contribution margin per haircut = Service charge - Variable expense

Contribution margin per haircut = $10 - $0 = $10

2)

Tota Fixed Cost per annum = (18000*5) + 4500 + 6000 = $100500

Annual Break even point = Fixed cost / Contribution margin per haircut

Annual Break even point = 100500/10 = 10050 haircuts per annum

3)

a) If last year's haircuts were 15000, then

Total Profit (Loss) = Total Rev. - Fixed cost = 15000 * 10 - 100500 = $49500

Profit per hair cut = $49500/15000 = $3.3 per haircut

b) If last year's haircuts were 16500, then

Total Profit (Loss) = Total Rev. - Fixed cost = 16500 * 10 - 100500 = $64500

Profit per hair cut = $64500/16500 = $3.91 per haircut

c) If last year's haircuts were 13500, then

Total Profit (Loss) = Total Rev. - Fixed cost = 13500 * 10 - 100500 = $34500

Profit per hair cut = $34500/13500 = $2.56 per haircut

4)

a) Variable cost = Commission to barbers = $10 * 50% = $5 per haircut

New contribution margin = $10 - $5 = $5

revised fixed cost = 4500 + 6000 = $10500

new break even point = 10500 / 5 = 2100 haircuts per annum

b) Variable cost = 10% per haircut to landlord = $10 * 10% = $1 per haircut

New contribution margin = $10 - $1 = $9

revised fixed cost = (18000*5) + 4500 + (100*12) = $95700

new break even point = 95700 / 9 = 10633.3 or 10634 haircuts per annum

c) Variable cost = 50% per haircut commission to barbers +10% per haircut to landlord =

($10 * 50%) + ($10 * 10%) = 5 + 1 = $6 per haircut

New contribution margin = $10 - $6 = $4

revised fixed cost = 4500 + (100*12) = $5700

new break even point = 5700 / 4 = 1425 haircuts per annum