Question

Cost-Volume-Profit

Jen & Berry’s sold 100,000 pints of ice cream last month according to the following contribution format income statement:

              Total $              Per Unit $

SALES                    $325,000               $3.25

VARIABLE COSTS              200,000                  2.00

CONTRIBUTION MARGIN       $ 125,000               $ 1.25

FIXED COSTS               50,000

NET INCOME               $ 75,000

A competing company, Un-Friendly’s, also sold 100,000 pints of ice cream last month according to the following contribution format income statement:

          Total $              Per Unit $

SALES                    $250,000               $2.50

VARIABLE COSTS              100,000               1.00

CONTRIBUTION MARGIN       $ 150,000               $ 1.50

FIXED COSTS               75,000

NET INCOME               $ 75,000

Both companies sold the same amount of ice cream and had the same Net Income but have different price and cost structures. Jen & Berry’s uses higher quality ingredients (variable cost) and charges a higher price than its competitor. Un-Friendly’s spends more on advertising (fixed cost) and sells at a lower price than Jen & Berry’s.

Analysis of Ice Cream Companies

1. Using last month’s income statements on page 2, calculate the Operating Leverage for each company.

2. If next month’s sales increased by 10% for both companies, would the Net Income for both companies once again be equal or would one company have higher profits than the other? Briefly explain.

3. If next month’s sales decreased by 10% for both companies, would the Net Income for both companies once again be equal or would one company have higher profits than the other? Briefly explain.

4. Using last month’s income statements on page 2, calculate the break-even point in units (pints of ice cream) for each company.

5. Using last month’s income statements on page 2, calculate the safety margin in units (pints of ice cream) for each company.

6. Jen & Berry’s is considering two options to increase sales next month (and hopefully profit):

Option #1:

Double the pints sold next month by decreasing the price by 25 cents to $3.00.

Option #2:

Double the pints sold next month by spending an additional $30,000 next month

(fixed cost) on advertising. Price of ice cream remains at $3.25 per pint.

Which option should Jen & Berry’s choose?? Explain your answer by showing calculations for both options.

7. Un-Friendly’s is considering the same two options to increase sales next month (and hopefully profit):

Option #1:

Double the pints sold next month by decreasing the price by 25 cents to $2.25.

Option #2:

Double the pints sold next month by spending an additional $30,000 next month

(fixed cost) on advertising. Price of ice cream remains at $2.50 per pint.

Which option should Un-Friendly’s choose?? Explain your answer by showing calculations for both options.

Answer 1

1) Operating Leverage = Contribution Margin/Net operating Income

  Operating Leverage of Jen & Berry = $125,000/$75,000 = 1.67

Operating Leverage of Un-Friendly = $150,000/$75,000 = 2.00

2) Contribution Format Income statement if sale increase by 10% next month (100,000 pints*1.10 = 110,000 pints) for both companies is shown as follows:-

Contribution Format Income statement (Amount in $)

Particulars	Jen & Berry (per unit) (a)	Jen & Berry (a*110,000)	Un-Friendly (per unit) (b)	Un-Friendly (b*110,000)
Sales	3.25	357,500	2.50	275,000
Less: Variable costs	2.00	(220,000)	1.00	(110,000)
Contribution Margin	1.25	137,500	1.50	165,000
Less: Fixed costs		(50,000)		(75,000)
Net Income		87,500		90,000

As we can see in the above income statement that net income of Jen & berry has increased from $75,000 to $87,500 whereas net income of Unfriendly has increased from $75,000 to $90,000. In this case the net income of Unfriendly will be higher than Jen & Berry by $2,500 ($90,000 - $87,500).

3) Contribution Format Income statement if sale decrease by 10% next month (100,000 pints*0.90 = 90,000 pints) for both companies is shown as follows:-

Contribution Format Income statement (Amount in $)

Particulars	Jen & Berry (per unit) (a)	Jen & Berry (a*90,000)	Un-Friendly (per unit) (b)	Un-Friendly (b*90,000)
Sales	3.25	292,500	2.50	225,000
Less: Variable costs	2.00	(180,000)	1.00	(90,000)
Contribution Margin	1.25	112,500	1.50	135,000
Less: Fixed costs		(50,000)		(75,000)
Net Income		62,500		60,000

As we can see in the above income statement that net income of Jen & berry has decreased from $75,000 to $62,500 whereas net income of Unfriendly has decreased from $75,000 to $60,000. In this case the net income of Jen & Berry will be higher than Unfriendly by $2,500 ($62,500 - $60,000).

4) Break even point using last month income statement

Break Even point (in pints) of Jen & berry = Fixed cost/Contribution margin per unit

= $50,000/$1.25 = 40,000 pints

Break Even point (in pints) of Unfriendly = Fixed cost/Contribution margin per unit

= $75,000/$1.50 = 50,000 pints