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 $1,400,000. 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 $300,000 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 $300,000 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

(b) Assuming an income tax rate of 38 percent, what dollar sales volume is currently required to obtain an after-tax profit of $300,000?
$Answer

(c) In the absence of income taxes, at what sales volume will both alternatives (automation and outsourcing) provide the same profit?
$Answer

(d) Briefly describe one strength and one weakness of both the automation and the outsourcing alternatives.

Automation has higher profits if sales increase. Outsourcing has less risk and a lower break-even point.

Automation has higher profits if sales increase and a lower break-even point. Outsourcing has less risk.

Automation has less risk and a lower break-even point. Outsourcing has higher profits if sales increase.

Automation has less risk. Outsourcing has higher profits if sales increase and a lower break-even point.

Answer 1

Answer 1

sales revenue	4200000
Less: variable cost @60% of sales	2520000
contribution margin	1680000
Less: fixed cost	1400000
Profit	280000
Contribution margin ratio (contribution margin / sales revenue)	40%
current break-even point in sales dollars( fixed cost/Contribution margin ratio) (1400000/0.40)	3500000

Answer 2

After tax profit	300000
add: tax expenses (300000*38/(100-38)	183871
before tax profit	483871
before tax profit	483871
add: Fixed cost	1400000
total contribution required to earn after tax profit 300000	1883871
total contribution required to earn after tax profit 300000	1883871
Contribution margin ratio	40%
sales volume is currently required to obtain an after-tax profit of $300,000 (1883871/0.40)	4709677.50

Answer 3

suppose sales is X.
profit	sales - variable cost - revised fixed cost
Profit under Automated processing equipment	X - (0.54X) -1700000
Profit under outsourcing for food processing	X - (0.65X) - 1100000
profit is equal for both option
Profit under Automated processing equipment = Profit under outsourcing for food processing
X - (0.54X) -1700000 = X - (0.65X) - 1100000
0.46X -1700000 = 0.35X - 1100000
0.46X -0.35X = - 1100000 +1700000
0.11X = 600000
X = 600000/0.11 = 5454545
sales volume level at both alternatives (automation and outsourcing) provide the same profit	5454545.5

Answer 4

Automation has higher profits if sales increase. Outsourcing has less risk and a lower break-even point.