Question

Bubba’s Western Wear is a western hat retailer in Lubbock, Texas. Although Bubba’s carries numerous styles of western hats, each hat has approximately the same price and invoice (purchase) cost, as shown in the following table. Sales personnel receive a commission to encourage them to be more aggressive in their sales efforts. Currently, the Lubbock economy is really humming, and sales growth at Bubba’s has been great. The business is very competitive, however, and Bubba, the owner, has relied on his knowledgeable and courteous staff to attract and retain customers who otherwise might go to other western wear stores. Because of the rapid growth in sales, Bubba is also finding the management of certain aspects of the business more difficult, such as restocking inventory and hiring and training new salespeople.

Sales price	$	80.00
Per unit variable expenses
Purchase cost		43.50
Sales commissions		11.50
Total per unit variable costs	$	55.00
Total annual fixed expenses
Advertising	$	98,500
Rent		146,500
Salaries		255,000
Total fixed expenses	$	500,000

Required:

1. Calculate the annual breakeven point, both in terms of units and in terms of sales dollars.

2. If Bubba’s sells 22,000 hats, what is its before-tax income or loss? Support your answer by preparing a contribution income statement.

3. If Bubba’s sells 32,000 hats, what is its margin of safety (MOS) and MOS ratio?

4. Bubba is considering the elimination of sales commissions completely and increasing salaries by $157,000 annually. What would be the new breakeven point in units? What would be the before-tax income or loss if 22,000 hats are sold with the new salary plan?

Answer 1

Variable cost per unit = $55

Total fixed costs = $500,000

Contribution margin = Selling price - Variable cost

= 80 - 55

= $25 per unit

Contribution margin ratio = Contribution margin/Selling price

= 25/80

= 31.25%

1.

Break even point (in units) = Fixed cost/Contribution margin per unit

= 500,000/25

= 20,000

Break even point ($) = Fixed cost/Contribution margin ratio

= 500,000/31.25%

= $1,600,000

2.

Contribution income statement

Sales (22,000 x 80)	1,760,000
Variable cost (22,000 x 55)	- 1,210,000
Contribution margin	550,000
Fixed cost	- 500,000
Before tax income	$50,000

3.

Margin of safety = Actual sales - Break even sales

= 32,000 x 80 - 1,600,000

= 2,560,000 - 1,600,000

= $960,000

Margin of safety ratio = Margin of safety/Actual sales

= 960,000/2,560,000

= 37.5%

4.

New fixed costs = 500,000 + 157,000

= $657,000

New variable cost per unit= $43.50

Contribution margin = Selling price - Variable cost

= 80 - 43.5

= $36.5 per unit

Break even point (in units) = Fixed cost/Contribution margin per unit

= 657,000/36.5

= 18,000

Contribution income statement

Sales (22,000 x 80)	1,760,000
Variable cost (22,000 x 43.5)	- 957,000
Contribution margin	803,000
Fixed cost	- 657,000
Before tax income	$146,000