Question

Midlands Inc. had a bad year in 2019. For the first time in its history, it operated at a loss. The company's income statement showed the following results from selling 75,000 units of product: net sales $ 1,500,000; total costs and expenses $ 1,900,000; and net loss $400,000. Costs and expenses consisted of the following. Total Variable Fixed 1,240,000 $755,000 $485,000 515,000 90,000 425,000 Administrative expenses 145,000 55,000 90,000 $1,900,000 $900,000 $1,000,000 Cost of goods sold Selling expenses Management is considering the following independent alternatives for 2020. Increase unit selling price 20% with no change in costs and expenses. Change the compensation of salespersons from fixed annual salaries totaling $195,000 to total salaries of $35,000 plus a 5% commission on net sales. Purchase new high-tech factory machinery that will change the proportion between variable and fixed cost of goods sold to 50:50 1. 2. 3.

Answer 1

Answers

• All working forms part of requirement
• Requirement ‘a’

Break Even point = $ 2,500,000

A	Net Sales	$         1,500,000
B	Variable Cost	$             900,000
C = A - B	Contribution margin	$             600,000
D = C/A	CM Ratio	0.4000
E	Total Fixed Cost	$         1,000,000
F = E/D	Break Even in $	$         2,500,000

• Requirement ‘b’

	Break Even point
1. Increasing selling price	$        2,000,000
2. Change compensation	$        2,400,000
3. Purchase machinery	$        2,316,327

--Which course is recommended?
Answer = #1 Increasing Selling price, because this is reducing Break Even level and cost is unchanged.

--Workings for above

#1: Increasing selling price
A	Current Sales	$         1,500,000
B = A x 20%	Increase in Sale	$             300,000
C = A + B	2020's sale	$         1,800,000
D	Variable Cost	$             900,000
E = C - D	Contribution margin	$             900,000
F = E/C	CM Ratio	0.5000
G	Total Fixed Cost	$         1,000,000
H = G/F	Break Even in $	$         2,000,000

#2 Change Compensation
	Variable Cost	Fixed Cost
Current	$             900,000	$         1,000,000
Old compensation		$          (195,000)
New compensation	$               75,000	$               35,000
New Costs for 2020	$             975,000	$             840,000
A	2020's sale	$         1,500,000
B	Variable Cost	$             975,000
C = A - B	Contribution margin	$             525,000
D = C/A	CM Ratio	0.350
E	Total Fixed Cost	$             840,000
F = E/D	Break Even in $	$         2,400,000

#2 Purchase machinery
	Variable Cost	Fixed Cost
Current	$      900,000	$               1,000,000
Old Cost of Goods Sold	$   (755,000)	$                 (485,000)
New Cost of Goods Sold	$      620,000	$                   620,000
New Costs for 2020	$      765,000	$               1,135,000
A	2020's sale	$               1,500,000
B	Variable Cost	$                   765,000
C = A - B	Contribution margin	$                   735,000
D = C/A	CM Ratio	0.490
E	Total Fixed Cost	$               1,135,000
F = E/D	Break Even in $	$               2,316,327