Question

roblem Island Novelties, Inc., of Palau makes two products, Hawaiian Fantasy and Tahitian Joy. Present revenue, cost, and sales data for the two products follow: Hawaiian Fantasy $15.00 S9.00 20,000 Tahitian Joy $100.00 S20.00 5,000 Selling price per unit ariable expenses per unit umber of units sold annuall Fixed expenses total $475,800 per year. The Republic of Palau uses the U.S. dollar as its currency Required 1. Assuming the sales mix given above, do the following a. Prepare a contribution format income statement showing both dollar and percent columns for each product and for the company as a whole b. Compute the break-even point in dollars for the company as a whole and the margin of safety in both dollars and percent 2. The company has just developed a new product to be called Samoan Delight. Assume that the company could sel 10,000 units at $45.00 each. The variable expenses would be $36.00 each. The company's fixed expenses would not change a. Prepare another contribution format income statement, including sales of the Samoan Delight (sales of the other two products would not change) b. Compute the company's new break-even point in dollars and the new margin of safety in both dollars and percent 3. The president of the company examines your figures and says, "There's something strange here. Our fixed costs haven't changed and you show greater total contribution margin if we add the nevw product, but you also show our break-even point going up. With greater contribution margin, the break-even point should go down, not up. You've made a mistake somewhere." Explain to the president what has happened

Answer 1

1.

	Hawaiian		Tahitian		Amount
	Amount	%	Amount	%	Amount	%
Sales	$300,000	100	$500,000	100	$800,000	100
Variable cost	$180,000	60	$100,000	20	$280,000	35
Contribution margin	$120,000	40	$400,000	80	$520,000	65
Fixed cost					$475,800
Net operating income					$44,200

Break even point = $475,800/65%

= $732,000

Margin of safety = $800,000-$732,000

= $68,000

Margin of safety (%) = $68,000/$800,000

= 8.5%

2.

	Hawaiian		Tahitian		Samoan		Total
	Amount	%	Amount	%	Amount	%	Amount	%
Sales	$300,000	100	$500,000	100	$450,000	100	$1,250,000	100
Variable cost	$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
Fixed cost							$475,800
Net operating income							$134,200

Break even point = $134,200/48.8% = $975,000

Margin of safety = $1,250,000-$975,000 = $275,000

Margin of safety (%) =$275,000/$1,250,000 = 22%

3.

Since, fixed cost is fixed. So, with the introduce of new product contribution margin of new product is positive and no fixed cost introduce. So, overall contribution margin rises.

Since overall sales increases with more increasing rate than contribution margin with the introduce of new product. Therefore break even point also increases.