Question

Swan Lake Company is engaged in producing ballet shoes for children aged 3 to 6. The current yearly sales of ballet shoes are 38,750 pairs at $120 per pair. The variable costs are $80 per pair and fixed costs are $950,000 per year. Jenny, the company's owner, is not satisfied with present profit level. She is planning to put forward one of the following three proposals: Proposal 1: Increase advertising expenditure of $80,000 to promote sales. It is estimated that the sales quantity will rise by 5%. Proposal 2: Reduce the variable costs per pair to $70. A 15% drop in sales quantity is expected as the shoes will be produced with materials of lower quality. Proposal 3: Lower unit selling price by 10% which will result in 4% increase in sales quantity. The drop in selling price could be justified by 20% decrease in fixed costs and 8% decrease in variable costs per pair. Required: (a) Calculate, for the current year: (i) Unit contribution margin and contribution margin ratio; (4 marks) (ii) Break-even sales [in units and in dollars ($)]; (4 marks) (iii) Margin of safety in units, and (2 marks) (iv) Operating income. (2 marks) (b) By comparing the current operating income in (a)(iv) and new operating income under each of the three proposals, advise Jenny which proposal should be adopted. (11 marks) (c) Discuss why it is important for management to understand cost-volume-profit analysis. (7 marks) (Total 30 marks)

Answer 1

A H I 4. Sales Volume 5 Sales 6 Less: Variable Cost 7 Contribution Margin 8 Less: Fixed Cost 9 Operating Income B C D E F G Question - (6) - Proposal - 2 should be adopted based on the Operating Income Current Proposal - 1 Proposal - 2 Per Pair Total Per Pair Total Per Pair Total 38,750 40,688 32,938 $ 120 $ 4,650,000 $ 120 S 4,882,500 $ 120 $ 3,952,500 $ 80 $ 3,100,000 $ 80 3,255,000 $ 70 2,305,625 $ 40 $ 1,550,000 $ 40 $ 1,627,500 $ 50 $ 1,646,875 $ 950,000 $ 1,030,000 $ 950,000 $ 600,000 $ 597,500 $ 696,875 Proposal-3 Per Pair Total 40,300 $ 108 $ 4,352,400 $ 74 $ 2,966,080 $ 34 $ 1,386,320 $ 760,000 $ 626,320 selling price decrease by 10%, increase in sale quantity by 4% decrease in fixed cost by 20%, decrease in variable cost per pair 8% Proposals Increase Advertising by $80,000 Sales Quantity rise by 5% Variable cost reduce to $70 Sales Quantity decrease by 15%

A B C D E F G H I Proposal - 2 Proposal-3 17 (a) Calcualtions (i) Unit Contribution Margin Current Proposal - 1 =(Sales per pair - Variable Cost per pair) =($120 - $80) =($120 - $80) 40$ =($120 - $70) $ =($108 - $74) $ 40 50 34 =(Sales per pair - Variable Cost per pair) / Sales Per Pair (i) Unit Contribution "=($120 - $80) / $120 =($120 - $80)/ $120 =($120 - $70) / $120 Margin Ratio 33% 33% 42% =($108 - $74)/$108 32% (ii) Break - even sales (in units) = Fixed Cost / Contribution Margin per pair =$950,000 / $40 = $1,030,000 / $40 23,750 =$950,000 / $50 =$760,000 / $34 25,750 19,000 22,093 29 (ii) Break - even sales (in dollars) = Fixed Cost / Contribution Margin ratio =$950,000 / 33% = $1,030,000 / 33% 2,850,000 $ 3,090,000 =$950,000 / 42/5 $ 2,280,000 =$760,000 / 32% $ 2,386,047 $ = Current Sales Units - Breakeven Point Units (iii) Margin of = 38,750 - 23,750 = 40,688 - 25,550 = 32,938 - 19,000 = 40,300 - 22,093 safety in units 15,000 14,938 13,938 18,207 37 (iv) Operating =(Sales Volume x Contribution margin per unit) - Fixed Cost 39 Income 600,000 $ 597,500 $ 696,875 $ 626,320 40 41 Cost Volume Profit analysis - It is important for the management as because, we want to know the sales based on the profit we want to 42 made. Through this we can sales or manufacture and can control where the costs can be reduced and can increase the profit or decrese 43 the selling price to get more sales.

Nm 1 B C D E F G Question - (b) - Proposal - 2 should be adopted based on the Operating Income Current Proposal - 1 Proposal - 2 Proposal-3 Per Pair Total Per Pair Total Per Pair Total Per Pair Total 38750 =C4+(C4*5%) =C4-(C4*15%) =C4+(C4*4%) 120 =C4*B5 120 =E4*D5 120 =G4*F5 =B5-(B5*10%) =14*H5 80 =C4*B6 80 =E4*D6 =G4*F6 =B6-(B6*8%) =14*H6 =B5-B6 =C5-C6 =D5-D6 =E5-E6 =F5-F6 =G5-G6 =H5-H6 =15-16 950000 =C8+80000 950000 =C8-C8*20%) =C7-C8 =E7-E8 =G7-G8 =17-18 4. Sales Volume 5 Sales 6 Less: Variable Cost 7 Contribution Margin 8 Less: Fixed Cost 9 Operating Income 70 Proposals Increase Advertising by $80,000 Sales Quantity rise by 5% Variable cost reduce to $70 Sales Quantity decrease by 15% selling price decrease by 10%, increase in sale quantity by 4% decrease in fixed cost by 20%, decrease in variable cost per pair 8% 16

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