Question

Need help answering these problems have no idea/clue. Any help appreciated.

Thornton 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 Bath oil Skin Crean 134,000 Color Gel 94,000 Budgeted sales in units (a) Expected sales price (b) Variable costs per unit (c) Income statenents Sales revenue (a x b) Variable costs (a xc) Contribution margin Fixed costs Net income 214,000 1e $1,072,000 1,284,000 $1,316,000 (268,900)(856,900) (940,000) 376,000 ー(648,000) (360,000) (124,000) 252,000 884,000 428,000 $ 156,0e0 68,000 Required a. Determine the margin of safety as a percentage for each product. b. Prepare revised income statements for each product, assuming a 20 percent increase in the budgeted sales volume. c. For each product, determine the percentage change in net income that results from the 20 percent increase in sales. d. Which product has the highest operating leverage? e. Assuming that management is pessimistic and risk averse, which product should the company add to its cosmetics line? f. Assuming that management is optimistic and risk aggressive, which product should the company add to its cosmetics line?

Answer 1

The margin of safety measures the amount of sales that exceed the break-even point.
Margin of safety $$=	actual sales- breakeven point
Margin of safety %=	(actual sales- breakeven point)/ actual sales
Break even point in units=	fixed expense- contribution margin
Contribution margin=	Sales price- variable expense
Break even point in $$=	fixed expense/ contribution margin ratio
Contribution margin ratio=	Contribution margin/ sales price
Operating Leverage =	[Quantity x (Price - Variable Cost per Unit)] / Quantity x (Price - Variable Cost per Unit) - Fixed Operating Cost

	Skin Cream	Bath Oil	Color Gel
Budgeted unit sales	134,000	214,000	94,000
Sales price	8	6	14
Varible cost	2	4	10
Contribution margin	6	2	4
Contribution margin ratio	75.00%	33.33%	28.57%
Total sales revenue	1,072,000	1,284,000	1,316,000
Variable cost	268,000	856,000	940,000
Contribution margin	804,000	428,000	376,000
Fixed cost	648,000	360,000	124,000
Net income	156,000	68,000	252,000
Fixed cost as % of sales	60.45%	28.04%	9.42%
Break even point	864,000	1,080,000	434,000
Mergin of safety	208,000	204,000	882,000
20% increase in volume
	Skin Cream	Bath Oil	Color Gel
Budgeted unit sales	160,800	256,800	112,800
Sales price	8	6	14
Varible cost	2	4	10
Contribution margin	6	2	4
Contribution margin ratio	75.00%	33.33%	28.57%
Total sales revenue	1,286,400	1,540,800	1,579,200
Variable cost	321,600	1,027,200	1,128,000
Contribution margin	964,800	513,600	451,200
Fixed cost	648,000	360,000	124,000
Net income	316,800	153,600	327,200
% change in net income	103.08%	125.88%	29.84%
Operating leverage	515.38%	629.41%	149.21%
		Highest

Pessimistic approach
Choose the product with lowest fixed cost so that if the sales don’t happen, the loss is minimized. Hence choose - color gel

Optimistic approach
Choose the product which has the lowest total cost at the current level of projections. Hence choose Bath Oil. This product shows the highest increase in net income for every % increase in the sales volume. Skin Cream has the highest contribution margin and thus should show the highest increase in net income but the fixed cost are 60% of sales as compared to 28% for bath oil. Hence, any benefits of higher sales are only realized when the sales increase 2.5-3 times the current projections