Question

Pizza Palace is a restaurant chain with operations across North America. The company operates using typical fast food operations, however is considering adding food trucks in order to increase business. Below is the CVP Income statement for Pizza Palace for the 1st quarter of 2020.  

Pizza Palace CVP Income Statement For the Quarter Ended March 31, 2020 $5,098,500 $3,104,500 557,000 157,600 Sales Revenue ($5.50 per pizza) Less Variable Expenses: Cost of Goods Sold Sales & Marketing Expenses General & Administrative Expenses Contribution Margin Less Fixed Expenses: Sales & Marketing Expenses General & Administrative Expenses Operating Income 3.819 100 $1,279,400 $370,000 277,200 647,200 $632,200

Pizza Palace would like to remain using the same supplier for its dough; however, the supplier is increasing its prices by $1/pound of dough. Each pound of dough makes 4 small pizzas (Hint: You will need to convert price per pound of dough to price per individual pizza.) Due to recent growth, Pizza Palace has decided to hire a new head chef that would cost the company $25,000 per quarter for the new position’s salary, as well additional kitchen space for an annual rent of $100,000 per year.

The company believes that it can reduce variable marketing expenses by $0.08 per pizza by increasing fixed marketing expenses by $35,500. With this new marketing scheme, the company believes it can generate a 8% increase in sales volume all the while keeping the price of each pizza at $5.50.  

The company wants to put these changes into place by the third quarter of 2020; however, it needs to answer a few questions internally before it decides to move forward.  

1. Management wants to obtain an understanding of the current situation before any changes are implemented. Calculate the following:

a. Find the unit contribution margin as well as the contribution margin ratio before the changes are implemented.  

b. Find the breakeven point in pizzas (units) and in sales dollars before the changes are implemented. Round the answers up to the next whole number.

c. Find the new unit contribution margin as well as the contribution margin ratio after the changes are implemented.  

d. Find the new breakeven in pizzas (units) and in sales dollars after the changes are implemented. Round the answers up to the next whole number.  

2. Based on the new cost structure, how many pizzas would the company need to sell to maintain an operating profit of $632,200? Round the answer up to the next whole number.  

3. Prepare a memo to the company’s Management explaining the following: What is the impact on the company’s Operating Income based on the above changes? Should the company proceed with all the changes? If yes, why? If no, what changes would you suggest if the company wants to stay with its current dough supplier?  

4. Another option for the company is to expand to another city under its current operating model of only selling one kind of pizza. In order to expand to another city, the company has decided that it will need to invest in an aggressive marketing campaign in the new city. The marketing campaign will cause another $425,000 in fixed marketing expenses to be incurred for the 1st quarter 2020. The company will also need to hire a new manager to run the new city’s operations at a quarterly salary cost of $35,500.

Pizza Palace

CVP Income Statement

For the Quarter Ended March 31, 2020

City A City B Total

Sales Revenue ($5.50 per pizza) $5,098,500 $2,475,000 $7,573,500 Less Variable Expenses:

Cost of Goods Sold $3,104,500 $1,507,500 $4,612,000 Marketing Expenses 557,000 270,000 827,000 General & Administrative Expenses 157,600 76,500 234,100 Contribution Margin $1,279,400 $621,000 $1,900,400

a. Based on this above information related to the possible expansion of the company, what is the impact to operating income as compared to the original Income Statement given on Page 1?  

b. What is the new breakeven in sales dollars?

c. Pizza Palace would like to ultimately have a total target profit of $1,000,000. How many pizzas must it sell to meet this target profit? Note: Round pizzas up to the whole pizza.

5. Explain whether Pizza Palace should expand to another city based on the calculations above. Also discuss other qualitative factors that impact the decision.

Answer 1

Current situation

Sales revenue per pizza 5.50

Total sales revenue 5,098,500

So the total sales are = total sales revenue/sales revenue per pizza

                                                =5,098,500/5.50 = 927,000 pizza

Cost of goods sold per pizza = 3104500/927000=3.3489

Selling and marketing cost per pizza=557000/927000=0.6008

General and administrative cost for pizza =157600/927000=0.1700

1

A)Contribution per pizza = sales revenue per pizza-( cost of goods sold per pizza+ Selling and marketing cost per pizza+ General and administrative cost for pizza)

=1.380

Contribution in dollars = as given 1279400

Contribution margin= 1279400/sales revenue =1279400/5098500=0.2509 ie 25.09 percent

B) break even point in pizzas = total fixed cost / contribution per pizza

                                =647200/1.38=468985.50 pizzas

Break even point in dollars = fixed cost /contribution margin

                                                =647200/25.09% = 2579513.75             

c) new sales revenue per pizza =5.50

cost of goods sold per pizza = 3.3849 (as previous + 0.25(increase in cost $1 per pound, given 1 pound gives 4 pizzas per pizza is ¼ ))=3.6349

sales in marketing per pizza =0.6008 as previous – 0.08(as cost reduced )=0.5208

general and administrative cost =0.1700

new contribution per pizza = sales revenue per pizza-( cost of goods sold per pizza+ Selling and marketing cost per pizza+ General and administrative cost for pizza)

=1.1743

Sales revenue increases by 8%= new sales= 5098500+8%=5506380

Sales in pizzas= 927000+8%=1001160

Contribution margin = (sales revenue- total variable cost) / sales revenue

= (5506380-(1001160*4.3257))/5506380 =21.35%

d) sales and marketing =370000 as pervious + 35500 as there is increase=405500

general and administrative =277200 as previous + 25000 +25000=327200

total fixed cost= 405500+327200=732700

break even point in pizzas = fixed cost / contribution per unit

=732700/1.1743=623946

Break even point in dollars = fixed cost/ contribution margin

                                =732700/21.35%=3431850

2)

If operating profit = 632200

Contribution in dollars = operating profit + fixed cost= 632200+732700=1364900

Number of pizzas to be sold= contribution in dollars / contribution per unit

= 1364900/1.1743=1162309.46

3)

Present situation contribution is higher than change in situation even the fixed cost in changed situation are higher resulting into lower profits.

Hence the present situation is profitable and preferable

4)

Aand B) break even point in dollar= fixed cost/ contribution margin

Contribution margin=( sales revenue- total variable cost)/ sales revenue=(7573500-5673100)/7573500

=25.09%

Total variable cost = ( cost of goods sold for 2 cities + Selling and marketing cost for 2 cities+ General and administrative cost for 2 cities)

Fixed cost: sales and marketing cost= 370000+425000=795000

General and admistrative=277200+35500=3127700

Total fixed cost=1107700

break even point in dollar= fixed cost/ contribution margin

=1107700/25.09%=4414906

c) if operating profit=1000000

contribution= fixed cost + operating profit

=10000000+1107700 =2107700

contribution per pizza= 1.38 (ie 5.50-4.1209( total variable cost / total sales in pizzas))

total sales in pizzas= total revenue/5.50 =1377000

total pizzas to be sold= 2107700/1.38=1527319

5)Current situation is better than expanding to 2 cities as the operating profit percentage to sales is lower in case of expansion

Operation profit/sales in 2 cities= 10.5%

Operating profit by sales in current situation = operating profit /sales=632200/59850012.40%