Question

Problem 9-37 CVP Analysis; Strategy [LO 9-1, 9-2, 9-3]

Bubba’s Western Wear is a western hat retailer in Lubbock, Texas. Although Bubba’s carries numerous styles of western hats, each hat has approximately the same price and invoice (purchase) cost, as shown in the following table. Sales personnel receive a commission to encourage them to be more aggressive in their sales efforts. Currently, the Lubbock economy is really humming, and sales growth at Bubba’s has been great. The business is very competitive, however, and Bubba, the owner, has relied on his knowledgeable and courteous staff to attract and retain customers who otherwise might go to other western wear stores. Because of the rapid growth in sales, Bubba is also finding the management of certain aspects of the business more difficult, such as restocking inventory and hiring and training new salespeople.

Sales price	$	80.00
Per unit variable expenses
Purchase cost		32.50
Sales commissions		22.50
Total per unit variable costs	$	55.00
Total annual fixed expenses
Advertising	$	207,500
Rent		203,000
Salaries		320,500
Total fixed expenses	$	731,000

Required:

1. Calculate the annual breakeven point, both in terms of units and in terms of sales dollars.

2. If Bubba’s sells 30,000 hats, what is its before-tax income or loss? Support your answer by preparing a contribution income statement.

3. If Bubba’s sells 43,000 hats, what is its margin of safety (MOS) and MOS ratio?

4. Bubba is considering the elimination of sales commissions completely and increasing salaries by $254,625 annually. What would be the new breakeven point in units? What would be the before-tax income or loss if 30,000 hats are sold with the new salary plan?

Answer 1

Answer to Part 1.

Unit Contribution Margin = Unit Sale Price - Unit Variable Cost

Unit Contribution Margin = $80.00 - $55.00 = $25.00

Break Even Point (Units) = Fixed Cost/ Unit Contribution Margin

Break Even Point (Units) = $731,000/ $25

Break Even Point (Units) = 29,240 Units

Break Even Point (Dollar Sales) = Break Even Point Units * Unit Sale Price

Break Even Point (Dollar Sales) = 29,240 * $80.00

Break Even Point (Dollar Sales) = $2,339,200

Answer to Part 2.

Before Tax Income/ (Loss) = Contribution Margin - Fixed Cost

Before Tax Income/ (Loss) = ($25.00 * 30,000) - $731,000

Before Tax Income/ (Loss) = $19,000

Contribution Margin Income Statement:

Sales (30,000 * $80.00)	2,400,000
Variable Cost (30,000 * $55.00)	1,650,000
Contribution Margin	750,000
Fixed Cost	731,000
Before Tax Income	19,000

Answer to Part 3.

Current Sales = 43,000 * $80.00 = $3,440,000

Margin of Safety = Current Sales - Break Even Sales

Margin of Safety = $3,440,000 - $2,339,200

Margin of Safety = $1,100,800

Margin of Safety Ratio = (Current Sales - Break Even Sales)/ Current Sales * 100

Margin of Safety Ratio = ($3,440,000 - $2,339,200)/ $3,440,000 * 100

Margin of Safety Ratio = 32.00%

Answer to Part 4.

Proposed Unit Variable Cost = $32.50

Proposed Unit Contribution Margin = $80.00 - $32.50 = $47.50

Proposed Fixed Cost = $731,000 + $254,625 = $985,625

Break Even Point (Units) = Fixed Cost/Unit Contribution Margin

New Break Even Point (Units) = $985,625/ $47.50

New Break Even Point (Units) = 20,750 Units

Before Tax Income/ (Loss) = Contribution Margin - Fixed Cost

Before Tax Income/(Loss) = (30,000 * $47.50) - $985,625

Before Tax Income/(Loss) = $439,375