Question

Benson Company is considering the addition of a new product to its cosmetics line. The company has three distinctly different options: a skin cream, a bath oil, or a hair coloring gel. Relevant information and budgeted annual income statements for each of the products follow.

Relevant Information Skin Cream 106,000 10 Bath Oil 186,000 Color Gel 66,000 12 Budgeted sales in units (a) Expected sales price (b) Variable costs per unit (c) Income statements Sales revenue (a b) Variable costs (a x c) Contribution margin Fixed costs $1,060,000 848,000 320,000 $1,116,000 $ 792,000 (186,000) 930,000 (396,000) 396,000 (528,000)(550,000 $380,000 Net income $ 294,000

Required:

1. Determine the margin of safety as a percentage for each product.

2. Prepare revised income statements for each product, assuming a 20 percent increase in the budgeted sales volume.

3. For each product, determine the percentage change in net income that results from the 20 percent increase in sales.

4. Which product has the highest operating leverage?

5. Assuming that management is pessimistic and risk averse, which product should the company add to its cosmetics line?

6. Assuming that management is optimistic and risk aggressive, which product should the company add to its cosmetics line?

Answer 1

a
	Skin Cream	Bath oil	Color gel
Expected sales price	10	6	12
Less: Variable costs per unit	2	1	6
Unit Contribution margin	8	5	6
Fixed costs	528000	550000	102000
Divide by Unit Contribution margin	8	5	6
Break even sales	66000	110000	17000
Budgeted sales	106000	186000	66000
Less: Break even sales	66000	110000	17000
Margin of safety sales	40000	76000	49000
Margin of safety	38%	41%	74%
b
	Skin Cream	Bath oil	Color gel
Sales revenue	1272000	1339200	950400
Variable costs	254400	223200	475200
Contribution margin	1017600	1116000	475200
Fixed cost	528000	550000	102000
Net income	489600	566000	373200
c
	Skin Cream	Bath oil	Color gel
Contribution margin	848000	930000	396000
Divide by Net income	320000	380000	294000
Degree of Operating leverage	2.65	2.45	1.35
X Percentage change in sales	20%	20%	20%
Percentage change in net income	53%	49%	27%
d
Skin cream has the highest operating leverage
e
Color gel should be added to its cosmetics line as it has highest margin of safety percentage
f
Skin cream should be added as it has the highest operating leverage