Problem 6-19 Break-Even Analysis; Pricing [LO6-1, LO6-4, LO6-5]

Minden Company introduced a new product last year for which it is trying to find an optimal selling price. Marketing studies suggest that the company can increase sales by 5,000 units for each $2 reduction in the selling price. The company’s present selling price is $98 per unit, and variable expenses are $68 per unit. Fixed expenses are $834,600 per year. The present annual sales volume (at the $98 selling price) is 26,000 units.

Required:

1. What is the present yearly net operating income or loss?

2. What is the present break-even point in unit sales and in dollar sales?

3. Assuming that the marketing studies are correct, what is the maximum annual profit that the company can earn? At how many units and at what selling price per unit would the company generate this profit?

4. What would be the break-even point in unit sales and in dollar sales using the selling price you determined in (3) above (e.g., the selling price at the level of maximum profits)?

Problem 6-20 CVP Applications: Break-Even Analysis; Cost Structure; Target Sales [LO6-1, LO6-3, LO6-4, LO6-5, LO6-6, LO6-8]

Northwood Company manufactures basketballs. The company has a ball that sells for $25. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable expenses are high, totaling $15.00 per ball, of which 60% is direct labor cost.

Last year, the company sold 38,500 of these balls, with the following results:

Required:

1. Compute (a) last year's CM ratio and the break-even point in balls, and (b) the degree of operating leverage at last year’s sales level.

2. Due to an increase in labor rates, the company estimates that next year's variable expenses will increase by $3.00 per ball. If this change takes place and the selling price per ball remains constant at $25.00, what will be next year's CM ratio and the break-even point in balls?

3. Refer to the data in (2) above. If the expected change in variable expenses takes place, how many balls will have to be sold next year to earn the same net operating income, $226,000, as last year?

4. Refer again to the data in (2) above. The president feels that the company must raise the selling price of its basketballs. If Northwood Company wants to maintain the same CM ratio as last year (as computed in requirement 1a), what selling price per ball must it charge next year to cover the increased labor costs?

5. Refer to the original data. The company is discussing the construction of a new, automated manufacturing plant. The new plant would slash variable expenses per ball by 40.00%, but it would cause fixed expenses per year to double. If the new plant is built, what would be the company’s new CM ratio and new break-even point in balls?

6. Refer to the data in (5) above.

a. If the new plant is built, how many balls will have to be sold next year to earn the same net operating income, $226,000, as last year?

b. Assume the new plant is built and that next year the company manufactures and sells 38,500 balls (the same number as sold last year). Prepare a contribution format income statement and compute the degree of operating leverage.

8.4 An airline is choosing between two engine systems for its planes. Each has the same useful life and the same repair record and maintenance costs.

? System A costs US$2 million and uses 30,000 gallons per 1,000 hours of operation at the average load of passenger service.

? System B costs US$3 million and uses 20,000 gallons per 1,000 hours of operation at the same level of passenger service.

In addition, the following information is relevant to both engine systems:

? Both systems have four-year lives before any major overhaul is required. At the end of the fourth year, each system has a salvage value equal to 10% of its initial investment.

? The fuel consumption of both systems is expected to increase at a rate of 5% per year because of degrading engine efficiency.

? The price of jet fuel on 31 March 2017 was US$15 per gallon. The airline will use this price to evaluate the two systems.

? The airline will assume 2,000 hours of operation per year and use a MARR of 10%.

Use the annual worth (AW) method to compare the two engine systems. Which one should the airline choose? Explain your answers in the following steps:

a) Calculate the annual equivalent cost of fuel (AWA(10%)fuel) for System A.

b) Calculate the total annual equivalent cost (AWA(10%)) of System A.

c) Calculate the annual equivalent cost of fuel (AWB(10%)fuel) for System B.

d) Calculate the total annual equivalent cost (AWB(10%)) of System B.

e) State your conclusion.

f) If the airline expects the price of jet fuel to rise significantly in the near future, will it make the same choice? Explain your answer briefly without any calculation.

8.4 An airline is choosing between two engine systems for its planes. Each has the same useful life and the same repair record and maintenance costs.

System A costs US$2 million and uses 30,000 gallons per 1,000 hours of operation at the average load of passenger service.

System B costs US$3 million and uses 20,000 gallons per 1,000 hours of operation at the same level of passenger service.

In addition, the following information is relevant to both engine systems:

Both systems have four-year lives before any major overhaul is required. At the end of the fourth year, each system has a salvage value equal to 10% of its initial investment.

The fuel consumption of both systems is expected to increase at a rate of 5% per year because of degrading engine efficiency.

The price of jet fuel on 31 March 2017 was US$15 per gallon. The airline will use this price to evaluate the two systems.

The airline will assume 2,000 hours of operation per year and use a MARR of 10%.

Use the annual worth (AW) method to compare the two engine systems. Which one should the airline choose? Explain your answers in the following steps:

a) Calculate the annual equivalent cost of fuel (AWA(10%)fuel) for System A.

b) Calculate the total annual equivalent cost (AWA(10%)) of System A.

c) Calculate the annual equivalent cost of fuel (AWB(10%)fuel) for System B.

d) Calculate the total annual equivalent cost (AWB(10%)) of System B.

e) State your conclusion.

f) If the airline expects the price of jet fuel to rise significantly in the near future, will it make the same choice? Explain your answer briefly without any calculation.

Mr Ahmad is the Chief financial officer for Johan Steel Sdn Bhd (“JSSB”) which is a subsidiary of an Singaporean company based in Port Klang. He has been working with this company since 2008. He is 44 years old and a Malaysian tax resident.

Mr Ahmad provided the following information in his income tax return for the year 2019:

RM

Salary per month                                                                                 15,000

Bonus for the year 2019                                                                     30,000

Service award                                                                                     10,000

Entertainment allowance per month                                                   2,000

Travelling allowance per month                                                         2,500

Leave passage to South Africa for family                                          25,000

Further information provided by the taxpayer for the year 2019 is as follows:

1. Mr Ahmad was given the option to buy 10,000 units of the company’s shares at the price of RM10 per share on 1 June 2019. The market value at that time was RM12 per share. He exercised his option on 21 November 2019 when the price was RM14 per share.

2. He incurred RM12,000 on entertainment expenditure on official duties. The travel allowance is for official duties.

3. The company (“JSSB”) provided a fully furnished bungalow to Mr Ahmad. The rental of

RM12,000 (including RM1,000 for furnishings) was paid for by the company. The company also paid for the gardener to look after the extensive garden.

4. He was provided with a new luxury car costing RM350,000 from the year 2016. JSSB bears the cost of fuel and repairs for Mr Ahmad. The company also provided him with a driver.

5. Mr Ahmad took an interest free loan of RM120,000 from his employer to finance the purchase of his second car. The loan was given from the equity funds of the employer. The interest payable for the loan would have been RM15,000 if it had been borrowed from a Malaysian commercial bank.

6. Mr Ahmad paid RM1,200 as subscription fees to his professional accounting body.

7. The employer paid for Mr Ahmad’s medical bills of RM22,000 when he was admitted to a private hospital.

Required:

Compute the statutory income of Mr Ahmad for the year of assessment 2019.

The owner of

New YorkNew York

Restaurant is disappointed because the restaurant has been averaging

4 comma 0004,000

pizza sales per​ month, but the restaurant and wait staff can make and serve

5 comma 0005,000

pizzas per month. The variable cost​ (for example,​ ingredients) of each pizza is

$ 1.15$1.15.

Monthly fixed costs​ (for example,​ depreciation, property​ taxes, business​ license, and​ manager's salary) are

$ 4 comma 000$4,000

per month. The owner wants cost information about different volumes so that some operating decisions can be made.Read the requirements

LOADING...

.

Requirement 1. Use the chart below to provide the owner with the cost information. Then use the completed chart to help you answer the remaining questions. ​(Enter total variable costs to the nearest dollar. Enter costs per​ pizza, price per​ pizza, and profit per pizza to the nearest​ cent.)

Enter any number in the edit fields and then click Check Answer.

Requirements

Northwood Company manufactures basketballs. The company has a ball that sells for $25. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable expenses are high, totaling $15.00 per ball, of which 60% is direct labor cost.Last year, the company sold 52,000 of these balls, with the following results:Sales (52,000 balls) $ 1,300,000Variable expenses 780,000Contribution margin 520,000Fixed expenses 321,000Net operating income $ 199,000Required:1. Compute (a) last year's CM ratio and the break-even point in balls, and (b) the degree of operating leverage at last year’s sales level.2. Due to an increase in labor rates, the company estimates that next year's variable expenses will increase by $3.00 per ball. If this change takes place and the selling price per ball remains constant at $25.00, what will be next year's CM ratio and the break-even point in balls?3. Refer to the data in (2) above. If the expected change in variable expenses takes place, how many balls will have to be sold next year to earn the same net operating income, $199,000, as last year?4. Refer again to the data in (2) above. The president feels that the company must raise the selling price of its basketballs. If Northwood Company wants to maintain the same CM ratio as last year (as computed in requirement 1a), what selling price per ball must it charge next year to cover the increased labor costs?5. Refer to the original data. The company is discussing the construction of a new, automated manufacturing plant. The new plant would slash variable expenses per ball by 40.00%, but it would cause fixed expenses per year to double. If the new plant is built, what would be the company’s new CM ratio and new break-even point in balls?6. Refer to the data in (5) above.a. If the new plant is built, how many balls will have to be sold next year to earn the same net operating income, $199,000, as last year?b. Assume the new plant is built and that next year the company manufactures and sells 52,000 balls (the same number as sold last year). Prepare a contribution format income statement and compute the degree of operating leverage.

4

Lavage Rapide is a Canadian company that owns and operates a large automatic car wash facility near Montreal. The following table provides data concerning the company’s costs:

For example, electricity costs are $1,000 per month plus $0.10 per car washed. The company expects to wash 8,300 cars in August and to collect an average of $6.50 per car washed.

Required:

Prepare the company’s planning budget for August.

5

Via Gelato is a popular neighborhood gelato shop. The company has provided the following cost formulas and actual results for the month of June:

While gelato is sold by the cone or cup, the shop measures its activity in terms of the total number of liters of gelato sold. For example, wages should be $6,500 plus $2.30 per liter of gelato sold and the actual wages for June were $21,300. Via Gelato expected to sell 6,400 liters in June, but actually sold 6,600 liters.

Required:

Calculate Via Gelato revenue and spending variances for June. (Indicate the effect of each variance by selecting "F" for favorable, "U" for unfavorable, and "None" for no effect (i.e., zero variance). Input all amounts as positive values.)

Suppose consumers spent $42 million on Christmas trees last year, when the average tree cost was $30. This year they spend $42 million, when the average tree costs $25. Assume that everything else remains constant. This data suggests that:​

Select one:

a.

​the demand for trees is inelastic.

b.

​total revenue to tree producers rose this year.

c.

​consumers bought the same number of Christmas trees this year as last year.

d.

​the price of the Christmas trees stayed the same.

e.

​the demand for trees is unit elastic.

Question 8

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Which of the following is likely to increase the supply of wheat?​

Select one:

a.

​A decrease in the price of corn

b.

​An increase in the cost of fertilizer

c.

​An increase in land prices

d.

​A decrease in the price of bread

e.

​An expectation that the price of wheat will be higher in near future

Question 9

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The figure below shows the cost and revenue curves for a monopolist. The deadweight loss arising under the monopoly is represented by the area:​

​

Figure 9.8

​

Select one:

a.

​eda.

b.

​dafc.

c.

​abf.

d.

​ecf.

e.

​dabc.

Question 10

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Which of the following goods will have a higher price elasticity of demand?​

Select one:

a.

​A good that represents a small proportion of the consumer’s budget.

b.

A good that is a necessity.

c.

​A good with few substitutes.

d.

​A good that is broadly defined.

e.

​A good with many substitutes.

Decision Making – Equipment Replacement

Mathews manages an assembly facility of Orthom Scientific. A supplier approaches Mathews about replacing a large piece of manufacturing equipment that Orthom uses in its process with a more efficient model. While the supplier made some compelling arguments in favor of replacing the 3-year-old equipment, Mathews is hesitant. Mathews is hoping to be promoted next year to manager of the larger plant near Orthom’s headquarters, and he knows that the accrual-basis net operating income of the assembly plant he manages will be evaluated closely as part of the promotion decision. The following information is available concerning the equipment replacement decision:

The historic cost of the old machine is $600,000. It has a current book value of $240,000, two remaining years of useful life, and a market value of $144,000. Annual depreciation expense is $120,000. It is expected to have a salvage value of $0 at the end of its useful life.

The new equipment will cost $360,000. It will have a 2-year useful life and a $0 salvage value. Orthom uses straight-line depreciation on all equipment.

The new equipment will reduce electricity costs by $70,000 per year and will reduce direct manufacturing labor costs by $60,000 per year.

For simplicity, ignore income taxes and the time value of money.

Required:

Assume that Mathews’ priority is to receive the promotion and he makes the equipment replacement decision based on next year’s accrual-based net operating income. Which alternative would he choose? Show your calculations.

What are the relevant factors in the decision? Which alternative is in the best interest of the company over the next 2 years? Show your calculations.

At what cost would Mathews be willing to purchase the new equipment? Explain.

3-bPrepare a journal entry to close any balance in the Manufacturing Overhead account to Cost of Goods Sold.

Record the entry to close any balance in the Manufacturing Overhead account to Cost of Goods Sold.\

4-