Question

Axelle Corporation has collected the following information after its first year of sales. Net sales were $2 million on 100,000 units, selling expenses were $400,000 (30% variable and 70% fixed), direct materials were $600,000, direct labour was $340,000, administrative expenses were $500,000 (30% variable and 70% fixed), and manufacturing overhead was $480,000 (20% variable and 80% fixed). Top managers have asked you to do a CVP analysis so that they can make plans for the coming year. They have projected that unit sales will increase by 20% next year.

Instructions:
(a) Calculate (1) the contribution margin for the current year and the projected year, and (2) the fixed costs for the current year. (Assume that fixed costs will remain the same in the projected year.)
(b) Calculate the break-even point in units and sales dollars.
(c) The company has a target operating income of $374,000. Calculate the required sales amount in dollars for the company to meet its target.
(d) Assume the company meets its target operating income number. Calculate by what percentage its sales could fall before it operates at a loss. That is, what is its margin of safety ratio?
(e) The company is considering a purchase of equipment that would reduce its direct labour costs by $140,000 and would change its manufacturing overhead costs to 10% variable and 90% fixed. (Assume the total manufacturing overhead cost is $480,000, as above.) It is also considering switching to a pure commission basis for its sales staff. This would change selling expenses to 80% variable and 20% fixed. (Assume the total selling expense is $400,000, as above.) Calculate (1) the contribution margin and (2) the contribution margin ratio, and (3) recalculate the break-even point in sales dollars. Comment on the effect each of management’s proposed changes has on the break-even point.

Answer 1

Solution a:

Axelle Corporation
Computation of Contribution Margin and Fixed cost - Current Year
Particulars	Per unit	Amount
Sales	$20.00	$2,000,000.00
Variable Cost:
Direct Material	$6.00	$600,000.00
Direct Labor	$3.40	$340,000.00
Variable Manufacturing Overhead ($480,000*20%)	$0.96	$96,000.00
Variable Selling Expenses ($400,000*30%)	$1.20	$120,000.00
Variable Administrative Expense ($500,000*30%)	$1.50	$150,000.00
Contribution	$6.94	$694,000.00
Fixed Cost:
Fixed Manufacturing Overhead ($480,000*80%)		$384,000.00
Fixed Selling Expenses ($400,000*70%)		$280,000.00
Fixed Administrative Expense ($500,000*70%)		$350,000.00
Total Fixed Cost		$1,014,000.00
Net Income		-$320,000.00

Axelle Corporation
Computation of Contribution Margin and Fixed cost - Projected Year
Particulars	Per unit	Amount
Sales	$20.00	$2,400,000.00
Variable Cost:
Direct Material	$6.00	$720,000.00
Direct Labor	$3.40	$408,000.00
Variable Manufacturing Overhead ($480,000*20%)	$0.96	$115,200.00
Variable Selling Expenses ($400,000*30%)	$1.20	$144,000.00
Variable Administrative Expense ($500,000*30%)	$1.50	$180,000.00
Contribution	$6.94	$832,800.00
Fixed Cost:
Fixed Manufacturing Overhead		$384,000.00
Fixed Selling Expenses		$280,000.00
Fixed Administrative Expense		$350,000.00
Total Fixed Cost		$1,014,000.00
Net Income		-$181,200.00

Solution b:

Breakeven point in units = Fixed cost / contribution per unit = $1,014,000 / 6.94 = 146110 units

Contribution margin ratio = Contribution per unit / selling price per unit = $6.94/$20 = 34.70%

Breakeven point in sales dollar = Fixed cost /contribution margin ratio = $1,014,000 / 34.70% = $2,922,190

Solution c:

Target operating income = $374,000

Target contribution = $374,000 + $1,014,000 = $1,388,000

Requried sales to achieve target operating income = Target contribution / contribution margin ratio

= $1,388,000 / 34.70% = $4,000,000

Solution d:

Margin of safety = (Current sales - Breakeven sales) / Current sales

= ($4,000,000 - $2,922,190) / $4,000,000 = 26.95%

Therefore sale should fall by 26.95% before it operates at a loss.