Question

Mr Zoo is planning to set up a mini Zoo in Howick.

The following relates to different pricing plans of visiting the zoo and costs of running the zoo.

Pricing Plan 1 - $30 per person (a special pack will be included)

Pricing Plan 2 - $25 per visitor (the special pack not to be included)

Variable Costs per visitor

Special Pack - $8

Zoo Consumables - $7

Zoo Expenses - $2

Total Fixed Costs - $200,000

REQUIRED:      Study the information above then answer the following questions.

Using the CVP formula, calculate the number of units (and its dollar amount) for achieving

Breakeven

A profit of $30,000 for both plans.

Calculate the Contribution Margin ratio for both plans.

Describe the meaning of Contribution Margin ratio.

Explain the relationship between Contribution Margin ratio and Number of Breakeven units.

Explain why it is important to calculate Margin of Safety.

State TWO examples of fixed cost in relation to the zoo.

Write a report to Mr Zoo for recommending which pricing plan should be adopted. Your recommendation should include at least ONE piece of financial and ONE piece of non-financial information.

Answer 1

1. Number of units (and its dollar amount) for achieving breakeven:

a) Plan 1 - Total fixed cost / contribution per unit = $ 200,000/$(30-8-7-2) = $200,000/$13 = 15,385 units ($15,385 x $30 = $461,550)

b) Plan 2 - Total fixed cost / contribution per unit = $ 200,000/$(25-7-2) = $200,000/$16 = 12,500 units ($12,500 x $25 = $312,500)

2. Number of units (and its dollar amount) for achieving Profit of $30,000 for both plans:

a) Plan 1 - Total fixed cost + Desired profit / contribution per unit = $ (200,000+30,000)/$(30-8-7-2) = $230,000/$13 = 17,693 units ($17,693 x $30 = $530,790)

b) Plan 2 - Total fixed cost + Desired profit / contribution per unit = $ 230,000/$(25-7-2) = $230,000/$16 = 14,375 units ($14,375 x $25 = $359,375)

3. Contribution Margin ratio for plan 1 = contribution margin / sales = 13/30 = 43.33%

Contribution Margin ratio for plan 2 = contribution margin / sales = 16/25 = 64%

4. The contribution margin ratio is the difference between a company's sales and variable expenses, expressed as a percentage. The total margin generated by an entity represents the total earnings available to pay for fixed expenses and generate a profit. When used on an individual unit sale, the ratio expresses the proportion of profit generated on that specific sale.

5. Break-even point is the amount of sales needed to pay for all of your costs in a period. Below break-even, you generate a loss; above it, you turn a profit. The contribution margin ratio reveals the percentage of sales that applies to your fixed costs after covering variable costs. When you know your contribution margin ratio, you can figure your break-even point in dollars and units with a couple of straightforward calculations. Your break-even point in dollars equals your total fixed costs for a particular period divided by your contribution margin ratio.

6. Margin of safety (MOS) is the difference between actual sales and break even sales. In other words, all sales revenue above the break-even point represents the margin of safety.

Margin of safety is an important figure for any business because it tells management how much reduction in revenue will result in break-even. A higher MOS reduces the risk of business losses. Generally, the higher the margin of safety, the better it is.

7. salary of staff, and portion of fixed electricity cost - are example of fixed cost