P5-24

1)
Details $$ $$
Selling Price per sweatshirt $13.5
Less: Variable Cost:
Purchase cost of sweatshirts $8
Commission to the student salespersons 1.5

9.5
4
Contribution Margin

Unit sales to attain $1200 Profit = Target profit/Unit contribution margin

=1200/4
= 300

Dollar Sales to attain 1200 Profit = 300 × 13.5

= $4,050

2)
Details Total
Selling Price $13.5
Less: Variable Expenses:
Commission Only 1.5
Contribution Margin 12

Since the fixed cost of $600(75× $8) must be recovered. The unit sales to Break even:
=FC/Unit CM
=600/12
=50
Dollar sales to Beark-even:
=50 × 13.5
=$675
P5-25
1) The contribution margin per unit of toy on first 16,000 unit is
Details total
Sales Price $3
Less: variable expenses 1.25
Contribution Margin 1.75

The contribution Margin per unit on anything over 16,000 units is:
Details Total
Sales Price $3
Less: variable expenses 1.4
Contribution Margin 1.6
Thus, for the first 16,000units sold the total amount of contribution margin generated would be
16000×1.75=$28,000
Since, the fixed cost on the first 16000units total $35,000 the $28,000 contribution margin above is not
enough to permit the company to break-even. Therefore in order to break-even more than 16,000nits
would have to be sold.
The fixed costs that will have to be covered by the additional sales are:
Details Total
Fixed cost on the first 16000 units $35,000
Less: contribution margin from the first 16000 units 28,000
Remaining unrecovered fixed cost 7000
Add : monthly rental cost of the additional space needed to produce more 1000
than 16000 units
Total fixed costs to be covered by remaining sales 8000

The additional sales of units required to cover these fixed costs would be :

Total remaining fixed costs/Unit contribution margin on added units

=8000/1.6
= 5,000 units

Therefore, a total of 21000 units (16000+5000) must be sold in order to the company to Break-even
Dollar sales to Break-even:
=21000×3
=$63,000

2) Target profit/unit contribution margin

=1200/1.6
=7,500 units
Thus, the company must sell 7,500 units above break-even point to earn a profit of $12000 each month.
These units, added to the 21,000 units required to break-even, equal total sales of 28,500 units
(21,000+7,500) each month to reach the target profit.
 3) The desired monthly profit would be:
25% × (35,000+1000)
=$9,000
Thus, target profit/unit contribution
=9000/1.6
= 6000 units
Therefore, the company must sell 6000 units above the break-even point to earn a profit of $9000 each
month. These units, added to the 21000 units required to break-even, would equal total sales of 27000
units (21000+6000) each month.

P5-27
Island Novelties, Inc

Contribution Format Income Statement

For the year Ended… 20xx

Hawaiian Fantasy Tahitian Joy Total

Details Amount % Amount % Amount %

Sales $ 300,000 100% $ 500,000 100% $ 800,000 100%

Less variable expenses 180,000 60% 100,000 20% 280,000 35%

Contribution margin $ 120,000 40% $ 400,000 80% $ 520,000 65%

Less fixed expenses 475,800

Net operation income 44,200

¿ Expense 475800
b) Dollar sales to Break-even = = =$ 732,000
CM Ration 0. 65

Margin of Safety = Actual sales – Break-even sales

= $ 800,000 - $ 732,000

= $ 68,000

Margin of safety ∈Dollars

Margin of safety percentage=
Actual sales
68,000
=
800,000
= 8.5%
2.

a)

Island Novelties, Inc

Contribution Format Income Statement

For the year Ended… 20xx

Hawaiian Fantasy Tahitian Joy Semon Delight Total

Details Amount % Amount % Amount % Amount %

Sales $300,000 100% $500,000 100% $450,000 100% $1,250,000 100%

Less variable expenses 180,000 60% 100,000 20% 360,000 80% 640,000 51.2%

Contribution margin 120,000 40% 400,000 80% 90,000 20% 610,000 48.8%
Less fixed expenses 475,800

Net operation income 134,200

¿ Expense 475800
b) Dollar sales to Break-even = = =$ 975,000
CM Ration 0. 488

Margin of Safety = Actual sales – Break-even sales

= $ 1,250,000 - $ 275,000

= $ 275,000

Margin of safety ∈Dollars

Margin of safety percentage=
Actual sales
275,000
=
1,250,000
= 22%

c) The reason for the increase in the Break-even point can be traced to the decrease in the company’s
overall contribution Margin ratio when the third product is added. Note from the income statements
above that this ratio drops from 65% to 48.8% with the addition of the third product. The third product
has a CM ratio only 20% which causes the average contribution margin per dollar sales to shift
downward.
This problem shows the somewhat tenuous nature of break-even analysis when the company has more
than one product. The analyst must be very careful of his or her assumptions regarding sales mix,
including the addition of new products.

It should be pointed out to the president that even though the break-even point is higher with the
addition of the third product, the company’s margin of safety is also greater. Notice that the margin of
safety increases from $ 68,000 to $ 275,000 or from 8.5% to 22%. Thus, the addition of third product
shifts the company much further from its break-even point, even though the break-even point is higher.

P5-33

1.

Details 15% Commission 20% Commission Sales Force

Total % Total % Total %

Sales $16,000,00 100% $16,000,000 100% $16,000,00 100%

0 0
Less: Variable Expense

Manufacturing 7,200,000
7,200,000 7,200,000
Commissions 3,200,000
2,400,000 1,200,000
Total Variable Expense 9,600,000 60% 10,400,000 65% 8,400,000 52.5%

Contribution Margin 6,400,000 40% 5,600,000 35% 2,600,000 47.5%

Less: Fixed Expenses

Manufacturing Overhead 2,340,000 2,340,000 2,340,000

Marketing 1,200,000 1,200,000 2,520,000

Administrative 1,800,000 1,800,000 1,725,000

Interest 540,000 540,000 540,000

Total Fixed Cost 4,800,000 4,800,000 7,125,000

Income Before Income Taxes 1,600,000 800,000 475,000

Income Taxes (30%) 480,000 240,000 142,500

Net Income 1,120,000 560,000 332,500

When the income before taxation is 0, income tax tends to be 0 too. So,

Dollar sales to Break-even

 ¿ Expense 4,800,000
a)
CM Ration
=
0. 4
= $ 12,000,000

Breakeven point in dollar sales when the commission increased by 20%

¿ Expense 4,800,000
b)
CM Ration
=
0. 35
= $ 13,714,285.71

break even point in dollar sales when the company employs it’s own workforce.

¿ Expense 7,125,000
c)
CM Ration
=
0. 475
= $ 15,000,000

2) In order to generate a 11,20,000 net income, the company must generate $1,600,000 in income
before taxes. Here,

Target income before taxes+ ¿ Expense

Dollar sales to Attain Target =
CM Ration
1,600,000+ 4,800,000
=
0.35

= $ 18,285,714.29

3) To calculate the volume of sales at which net income would be equal under either the 20%
commission plan or the company sales force plan, we find the volume of sales where cost before income
taxes under the two plans are equal.

Let,

x= Total sales revenue

=> 0.65x + 4,800,000 = 0.52x + 7,123,000

=> 0.125x= 2,325,000

x= $ 18,600,000

consequently, at a sales level of $18,600,000 both the plans would denote the same income before
taxes and net income. Below this sales level the commission plan would relent the largest income.
Above this sales level, the sales force plan would relent the biggest amount of income.

Contribution Margin
4) Degree of Operating leverage (DOL) =
Income Before Tax
 6 , 400,000
a) DOL = =4
1,600,000

5,6 00,000
b) DOL = =7
800,000

7,6 00,000
c) DOL = = 16
475,000

5) We should continue to use the sales agents for at least one more year, and possible for two more
years. The reasons are as follows:

i. The sales force plan will be highly acceptable since it will magnify fixed costs (and decrease
variable costs).if we consider One or two years from now, when sales have reached the $
18,600,000 level, the company can benefit considerably from this leverage. For the moment,
profit will be huge and risks will be mitigated by staying with the agents, even at the 20% higher
commission rate.
ii. Use of the sales agents would have a less dramatic effects on net income
iii. The sales force plan doesn’t become more advantageous than the usage of sales agents until the
company reaches sales of $ 8,600,000 a year. This level probably won’t be reached for at least
one more year, and possibly two years.
iv. Use of the sales agents for at least one more year would give the company more time to hire
competent people and get the sales group organized.