Question

Target Profit

Refer again to the income statements for Cover-to-Cover Company and Biblio Files Company on their respective Income Statement. Note that both companies have the same sales and net income. Answer questions (1) - (3) that follow, assuming that all data for the coming year is the same as the current year, except for the amount of sales.

1. If Cover-to-Cover Company wants to increase its profit by $40,000 in the coming year, what must their amount of sales be?
$fill in the blank

2. If Biblio Files Company wants to increase its profit by $40,000 in the coming year, what must their amount of sales be?
$fill in the blank

3. What would explain the difference between your answers for (1) and (2)?

a. Biblio Files Company has a higher contribution margin ratio, and so more of each sales dollar is available to cover fixed costs and provide operating income.

b. Cover-to-Cover Company’s contribution margin ratio is lower, meaning that it’s more efficient in its operations.

c. The companies have goals that are not in the relevant range.

d. The answers are not different; each company has the same required sales amount for the coming year to achieve the desired target profit.

Income Statement - Cover-to-Cover

Cover-to-Cover Company Contribution Margin Income Statement For the Year Ended December 31, 20Y8
Sales		$419,000
Variable costs:
Manufacturing expense	$251,400
Selling expense	20,950
Administrative expense	62,850	(335,200)
Contribution margin		$83,800
Fixed costs:
Manufacturing expense	$5,000
Selling expense	4,000
Administrative expense	11,950	(20,950)
Operating income		$62,850

Income Statement - Biblio Files

Biblio Files Company Contribution Margin Income Statement For the Year Ended December 31, 20Y8
Sales		$419,000
Variable costs:
Manufacturing expense	$167,600
Selling expense	16,760
Administrative expense	67,040	(251,400)
Contribution margin		$167,600
Fixed costs:
Manufacturing expense	$86,750
Selling expense	8,000
Administrative expense	10,000	(104,750)
Operating income		$62,850

Answer 1

1. Cover to cover company

Contribution Margin ratio (CMR) = (Contribution margin / sales) * 100

Contribution Margin = 83,800

Sales = 419,000

CMR = (83,800 / 419,000) * 100 = 20%

Fixed cost = 20,950

Amount of sales to earn desired profit = ( Fixed cost + Desired profit) / CMR

Desired profit = Current profit + desired increase in profit

Current profit = 62,850

Desired profit = 62,850 + 40,000 = 102,850

Amount of sales to earn desired profit = ( 20,950 + 102,850) / 20% = $619,000

2. Biblio Files company

Contribution Margin ratio (CMR) = (Contribution margin / sales) * 100

Contribution Margin = 167,600

Sales = 419,000

CMR = (167,600 / 419,000) * 100 = 40%

Fixed cost = 104,750

Amount of sales to earn desired profit = ( Fixed cost + Desired profit) / CMR

Desired profit = Current profit + desired increase in profit

Current profit = 62,850

Desired profit = 62,850 + 40,000 = 102,850

Amount of sales to earn desired profit = ( 104,750 + 102,850) / 40% = $519,000

3. Option a is correct. Biblio files company has a higher contribution margin ratio, and so more of each sales dollar is available to cover fixed cost and provide operating income.