Question

Case 1 – Cost-Volume-Profit Analysis

Janet Jennings is the general manager for Mercashoe Store. She is currently working on a major promotional campaign. Her ideas include the installation of a new lighting system and increased display space that will add $24,000 in fixed costs to the existing fixed costs. In addition, Janet is proposing a 5% price decrease ($40 to $38) that will produce a 20% increase in sales volume (20,000 to 24,000). Variable costs will remain at $24 per pair of shoes. Management is impressed with Janet’s ideas but concerned about the effects theses changes will have on the break-even point and the margin of safety.

Information provided:

A. Rental expenses for the store: $5,000 per month.

B. Janet has a salary assigned of $60,000 per year.

C. The store has a sales manager who earns $45,000 per year.

D. There are three salesclerks who have a salary assigned of $25,000 each per year.

E. Social security expenses for each the employees represent 30% of their salary.

F. Utilities expense: $600 per month.

Instructions:

1. Compute the current break-even point in units and compare it to the break-even point in units if Janet’s ideas are implemented.

2. Compute the contribution margin ratio under current operations and after Janet’s changes are introduced. (Round to the nearest full percent).

3. Compute the margin of safety under the two proposals.

4. What is the operating income under each scenario?

5. Prepare a CVP (Cost-Volume-Profit) income statement for current operations and after Janet’s changes are introduced.

6. Prepare a Cost-Volume-Profit graph under the two scenarios.

7. Prepare a report explaining and justifying whether Janet’s changes should be adopted or not and provide suggestions supported by the information provided above. Show your work in Word of Excel

Answer 1

Ans.
1. Compute the current break-even point in units and compare it to the break-even point in units if Janet’s ideas are implemented.
	Current operations	under Janet’s ideas
Break even point in units (fixed cost / contribution per unit)	17700	21943
2. Compute the contribution margin ratio under current operations and after Janet’s changes are introduced. (Round to the nearest full percent).
	Current operations	under Janet’s ideas
Contribution margin per unit (contribution/sales)	40%	37%
3. Compute the margin of safety under the two proposals.	Current operations	under Janet’s ideas
Margin of safety (sales - Break even point in value)	$           92,000	$              78,166
4. What is the operating income under each scenario?	Current operations	under Janet’s ideas
Operating Income (contribution-fixed cost)	$           36,800	$              28,800
5. Prepare a CVP (Cost-Volume-Profit) income statement for current operations and after Janet’s changes are introduced.
Particular	Current operations	under Janet’s ideas
Sales Volume (assumed it is for per year)	20000 units	24000 units
Sales Price per unit	$                   40	$                      38
Total Sales	$       8,00,000	$          9,12,000
Less: Variable Cost @ $24 per pair	$       4,80,000	$          5,76,000
Contribution	$       3,20,000	$          3,36,000
Contribution per unit	$                   16	$                      14
Contribution margin per unit (contribution/sales)	40%	37%
Less: Fixed Cost
A. Rental expenses for the store: $5,000 per month.	$     60,000.00	$        60,000.00
B. Janet' salary	$     60,000.00	$        60,000.00
C. sales manager 'salary	$     45,000.00	$        45,000.00
D. 3 salesclerks with salary of $25,000 each per year.	$     75,000.00	$        75,000.00
E. Social security expenses for each the employees represent 30% of their salary.	$     36,000.00	$        36,000.00
(30 % of (45000 & 75000)
F. Utilities expense: $600 per month.	$       7,200.00	$          7,200.00
G. Additional Fixed cost under Janet' idea	0	$        24,000.00
Total Fixed cost	$ 2,83,200.00	$    3,07,200.00
Break even point in units (fixed cost / contribution per unit)	17700	21943
Break even point in value (BEP in units * sales price)	$       7,08,000	$          8,33,834
Margin of safety (sales - Break even point in value)	$           92,000	$              78,166
Operating Income (contribution-fixed cost)	$     36,800.00	$        28,800.00
6. Prepare a Cost-Volume-Profit graph under the two scenarios.
attached
7
Ans. As per income statement it is visible that current situation is more profitable than janet' new idea graph