Question

Lemon Ltd. offers executive training seminars using, in part, recorded lectures of a well-known speaker. The agreement calls for Lemon to pay a royalty for the use of the lectures. The lecturer's agent offers Lemon two options. The first option is revenue-based and Lemon agrees to pay 25 percent of its revenues to the speaker. The second option is a flat rate of $375,600 annually for the use of the lectures in these seminars. The royalty agreement will run one year and the royalty option chosen cannot be changed during the agreement. All other royalty terms are the same.

Lemon charges $1,600 for the seminar and the variable costs for the seminar (excluding any royalty) is $400. Annual fixed costs (excluding any royalties) are $563,400.

Required:

a. What is the annual break-even level assuming:

1. 1. The revenue-based royalty agreement?
2. 2. The flat-rate royalty agreement?

b. At what annual volume would the operating profit be the same regardless of the royalty option chosen?

c. Assume an annual volume of 1,500 seminars. What is the operating leverage assuming:

1. 1. The revenue-based royalty agreement?
2. 2. The flat-rate royalty agreement?

d. Assume an annual volume of 1,500 seminars. What is the margin of safety assuming:

1. 1. The revenue-based royalty agreement?
2. 2. The flat-rate royalty agreement?

Answer 1

Angues Pageno Variable cost Royality contribution Revenue-based flat rate Selling Price $1600 $ 1600 ($400) ($400) C$400) $800 $ 1200 Margin Fixed Cost $ 56 3400 Revenue based Royality = 1500 x 25% =$400 flat rate fixed cost = 563400 +375600 = $ 939,000 a) Annual break-Even leved alluming D Revenue baked, break fixed cost Eeven level Contribution Margin 563400 800 = 704 Seminar

Pageno Revene baked, boreak Evenleved Fou Seminars 2 flat rate sroyality agrement, Break Even leved= $939000 $1200 782 Seminars Flat rate royality agreement, Bruak Even level -482 şeminare Point of indifference X Sales 800 X - 563400 563400 = 1200 x 939000 939000-563400 = 1200 x-800 x 375,600 = 4002 => x= 375,600 400 se = 939 &= sales = 939 c) D Revenue base soyality agreement operating leverage aluming

Pageno Contribution margin = 1500 şeminerl x$800 = $ 200,000 operating income = (1500 şeminarx $809-563400 $1200000563400 operating leverage $636,600 Contribution margin opeorating Poncomo $ 1200000 U 636 600 contribution marg Opesating leverage = 1182 2) flat rate royalty agoree monde = 1 500 şeminarl y $1200 – $1800000 operating in come = (1500 x$1200) -93900 1800 000 -939000 = 861,000 operating leverage operatin leverage 11 1800000 86 1000 = 2.09

Pageno d) Hargin of safety assuming D Revenue baled royalty agoredemont Margin of safety 796 Seminars ( break Even Morgive of safety = 196 seminarl = 1500 seminarl 7 ou seminare level=104 a) flat rate royalty agreement Margie of safety = 1500 Seminars - 782 seminars 718 Seminars (iloreak Even level=182) Hoogie of safety = 718 Seminars