Question

Walton 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 Bath Oil 138,000 218,000 10 2 Color Gel 98,000 16 10 Budgeted sales in units (a) Expected sales price (6) Variable costs per unit (c) Income statements Sales revenue (a x b) Variable costs (a X c) Contribution margin Fixed costs Net income $1,380,000 (276,000) 1,104,000 (912,000) $ 192,000 $1,962,000 (872,000) 1,090,000 (950,000) $ 140,000 $1,568,000 (980,000) 588,000 (198,000) $ 390,000 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? Complete this question by entering your answers in the tabs below. Reg A Reg B Reg C1 Reqs C2 to E Determine the margin of safety as a percentage for each product. (Round your answers to whole percentage values.) Skin Cream Bath Oil Color Gel Margin of safety % % % ReqA ReqB >

Answer 1

Margin of safety is the excess of actual sales revenue over the break-even sales revenue.

a. Determination of the Margin of Safety as a percentage for each product-

Margin of safety = (Actual Sales Revenue - Break even sales revenue)/Actual Sales Revenue

Actual Sales Revenue has been given in question as

Particulars	Skin Cream	Bath oil	Color gel
Actual sales revenue $	1380000	1962000	1568000

Break Even sales revenue = Fixed Cost / Profit Volume Ratio (P/V ratio)

Where Profit Volume Ratio = (Selling price per unit - Variable cost per unit)/Selling price per unit

	Particulars	Skin Cream	Bath oil	Color gel
a	Fixed Cost	912000	950000	198000
b	Profit Volume Ratio = (SPU - VCU)/SPU	80.00%	55.56%	37.50%
c	Break Even sales (Fixed Cost/P/V Ratio)	1140000	1710000	528000

Where SPU stands for Selling price per unit

VCU stands for variable cost per unit

So Margin of Safety will be as follows -

	Particulars	Skin Cream	Bath oil	Color gel
a	Actual Sales Revenue	1380000	1962000	1568000
b	BEP Sales	1140000	1710000	528000
c	Margin of Safety (a-b)/c	17.39%	12.84%	66.33%

b. Preparation of revised income statement for each product, assuming 20% increase in the budgeted sales volume -

	WALTON COMPANY
	Income Statements
	Particulars	Skin Cream	Bath oil	Color gel
a	Budgeted Sales Volume	138000	218000	98000
b	20 % increase in budgeted sales volume (a*1.20)	165600	261600	117600
c	Expected sales price (Given in question)	10	9	16
d	variable cost per unit (Given in question)	2	4	10
e	Sales Revenue (c*b)	1656000	2354400	1881600
f	variable cost (d*b)	331200	1046400	1176000
g	Contribution Margin (e-f)	1324800	1308000	705600
h	Fixed Cost	912000	950000	198000
i	Net Income	412800	358000	507600

(c) Determination of the % change in net income that results from the 20% increase in sales -

	WALTON COMPANY
	Income Statements
	Particulars	Skin Cream	Bath oil	Color gel
a	Earlier Net Income	192000	140000	390000
b	New Income after 20% increase in sales	412800	358000	507600
c	Increase in Net income	220800	218000	117600
d	% change in net income (increase in net income(c)/earlier net income(a)	115.00%	155.71%	30.15%

d. Calculation of Operating Leverage -

Operating Leverage is caused due to fixed operating expenses in a firm.

Operating leverage = contribution /EBIT

	Particulars	Skin Cream	Bath oil	Color gel
a	Contribution Margin	1104000	1090000	588000
b	EBIT	192000	140000	390000
c	operating Leverage (a/b)	5.75	7.79	1.51

Skin cream products has highest operating leverage.

e. If management is pessimistic and risk averse then management should opt Colour gel as it has lowest fixed cost & highest pre tax net income.

(f) If management is optimistic & risk aggressive then management should opt skin cream as it has lowest variable cost.

Please check with your answer and let me know.