Question

Case: Cost Structures for Global Shippers Inc. Management from Global Shippers Inc, an international shipping business, is in the process of assessing the choice between two different cost structures for the business. Option A has relatively higher variable costs per unit shipped but lower annual fixed costs, while Option B has the opposite relatively lower variable costs in its cost structure but higher fixed costs. Assume that delivery selling prices per unit are constant. The table below contains critical information in making the decision: Cest Information Option A Option B Delivery price revente per shipmen100 100 Variable cost per shipment delivered SRS 360 Contribution Margin per unit 15 40 Fixed costs (anal) 1,450,000 $4,700,000 Management wants you to write a professional report, answering the following questions: Questions 1) What is the break-even point, in terms of volume (i.e., number of shipments per year), for Option A? Option B? (2) How many shipments would have to be made under Option A to produce operating income of S43,000 for an annual period? (3) How many shipments per month would have to be made under Option A to produce an annual operating margin equal to 11% of sales revenue? (4) How many shipments are required under Option B to produce net income of $213,000 per year, given a corporate tax rate of 25%? (5) Assume that for the coming year total fixed costs are expected to decrease by 8% for each of the two options. What is the new break-even point, in terms of number of shipments, for each option? By what percentage did the break-even point change for each case? How do these figures compare to the percentage increase in budgeted fixed costs? (6) Assume an average income tax rate of 35%. What volume (number of shipments) would be needed to generate net income of 8% of revenue for cach option? (7) Which option do you think is the more profitable one for this business? Explain. (8) Which option do you consider to be more risky to the business? Explain (calculate degree of operating leverage to help answer this question).

Answer 1

Please find below the solution for the first four questions

1) Break-even point in terms of volume is calculated by the below formula:

Fixed cost/ ( selling price per unit - variable cost per unit)

Particular	Option A	Option B
Break-even point (units)	96667	117500

2) For calculating the shipments under option A we calculated the contribution amount and divided the number by contribution margin (15) to arrive at the shipments to be made (units) to produce operating income of $43000

Particular	Option A
Operating income	$              43,000
Add: Fixed cost	$        1,450,000
Contribution	$        1,493,000
Shipments to be made (units)	99533

3) For finding the number of shipments per month in order to maintain an 11% annual operating margin we have to find the per unit distribution of the fixed cost (i.e. 4% of revenue) and arrive at the Revenue figure. Now dividing the revenue number by 100 will give the units for the year (i.e 362500) now dividing the year details by 12 will give the monthly shipment unit.

Particular	Option A	Distribution
Revenue	$        36,250,000	$              100
VC	$        30,812,500	$                85
Contibution	$          5,437,500	$                15
Fixed cost	$          1,450,000	$                  4
Operating income	$          3,987,500	$                11
Shipment per year	362500
Monthly shipments	30208

4) To find the shipments required we have to back-calculate from the net operating income and add the items to arrive at the revenue number and divided the revenue by 100 to arrive at the units to be shipped

Particular	Option B
Units	124600
Revenue	$        12,460,000
VC	$          7,476,000
Contribution	$          4,984,000
Fixed cost	$          4,700,000
Operating income	$              284,000
Tax @ 25%	$                71,000
Net Operating income	$              213,000