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. Budgeted sales in units (a) Expected sales price (b) Variable costs per unit (c) Income statements Sales revenue (a x b) Variable costs (ax c) Contribution margin Fixed costs Net income Relevant Information Skin Cream Bath 011 Color Gel 138,000 218,000 98,000 $ 10 $ 9 $ 16 2 $ 4 $ 10 $1,380,000 $1,962,000 $1,568,000 (276,000) (872,000) (980,000) 1,104,000 1,090,000 588,000 (912,000) (950,000) (198,000) $ 192,000 $ 140,000 $ 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. Assuming that management is pessimistic and risk averse, which product should the company add to its cosmetics line? e. 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. Req A Reg B Reqc Reg D 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 % %

Answer 1

Solution:

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

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 ($)	1,380,000	1,962,000	1,568,000

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 ($)	912,000	950,000	198,000
b	Profit Volume Ratio = (SPU - VCU)/SPU	(10-2)/10	(9-4)/9	(16-10)/16
		80.00%	55.56%	37.50%
c	Break Even sales ($) (Fixed Cost/P/V Ratio)	1,140,000	1,710,000	528,000

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 ($)	1,380,000	1,962,000	1,568,000
b	BEP Sales ($)	1,140,000	1,710,000	528,000
c	Margin of Safety (a-b)/c	17%	13%	66%

Requirement 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	138,000	218,000	98,000
b	20 % increase in budgeted sales volume (a*1.20)	165,600	261,600	117,600
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) ($)	1,656,000	2,354,400	1,881,600
f	variable cost (d*b) ($)	331,200	1,046,400	1,176,000
g	Contribution Margin (e-f) ($)	1,324,800	1,308,000	705,600
h	Fixed Cost ($)	912,000	950,000	198,000
i	Net Income ($)	412,800	358,000	507,600

Requirement 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 ($)	192,000	140,000	390,000
b	New Income after 20% increase in sales ($)	412,800	358,000	507,600
c	Increase in Net income ($)	220,800	218,000	117,600
d	% change in net income (increase in net income(c)/earlier net income(a)	115%	156%	30%

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

Requirement e. If management is optimistic & risk aggressive then management should opt skin cream as it has lowest variable cost.

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