Question

Lorge Corporation has collected the following information after its first year of sales. Sales were $2,500,000 on 100,000 units; selling expenses $250,000 (40% variable and 60% fixed); direct materials $1,351,000; direct labor $250,000; administrative expenses $270,000 (20% variable and 80% fixed); and manufacturing overhead $350,000 (70% variable and 30% fixed). Top management has asked you to do a CVP analysis so that it can make plans for the coming year. It has projected that unit sales will increase by 10% next year.

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Compute (1) the contribution margin for the current year and the projected year, and (2) the fixed costs for the current year. (Assume that fixed costs will remain the same in the projected year.)

(1)		Contribution margin for current year		$
		Contribution margin for projected year		$
(2)		Fixed costs for current year		$

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Compute the break-even point in units and sales dollars for the first year. (Round contribution margin ratio to 2 decimal places e.g. 0.15 and final answers to 0 decimal places, e.g. 2,510.)

Break-even point			units
Break-even point		$

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The company has a target net income of $160,000. What is the required sales in dollars for the company to meet its target?

Sales dollars required for target net income

$

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If the company meets its target net income number, by what percentage could its sales fall before it is operating at a loss? That is, what is its margin of safety ratio? (Round answer to 1 decimal place, e.g. 10.5.)

Margin of safety ratio

%

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The company is considering a purchase of equipment that would reduce its direct labor costs by $110,000 and would change its manufacturing overhead costs to 30% variable and 70% fixed (assume total manufacturing overhead cost is $350,000, as above). It is also considering switching to a pure commission basis for its sales staff. This would change selling expenses to 90% variable and 10% fixed (assume total selling expense is $250,000, as above). Compute (1) the contribution margin and (2) the contribution margin ratio, and recompute (3) the break-even point in sales dollars. (Round contribution margin ratio to 2 decimal places, e.g. 25.25 and all other answers to 0 decimal places, e.g. 2,520. Use the current year numbers for calculations.)

1.		Contribution margin		$
2.		Contribution margin ratio			%
3.		Break-even point		$

Answer 1

ANSWER

Compute (1) the contribution margin for the current year and the projected year, and (2) the fixed costs for the current year. (Assume that fixed costs will remain the same in the projected year.)

	Current Year
Net sales	2,500,000
Variable costs
Direct materials	1,351,000
Direct labor	250,000
Manufacturing overhead ($350,000 X .70)	245000
Selling expenses ($250,000 X .40)	100000
Administrative expenses ($270,000 X .20)	54000
Total variable costs	2,000,000
Contribution margin	500,000

	Current Year	Increase	Projected Year
Net sales	2,500,000	1.1	2750000
Variable costs
Direct materials	1,351,000	1.1	1486100
Direct labor	250,000	1.1	275000
Manufacturing overhead ($350,000 X .70)	245000	1.1	269500
Selling expenses ($250,000 X .40)	100000	1.1	110000
Administrative expenses ($270,000 X .20)	54000	1.1	59400
Total variable costs	2,000,000	1.1	2200000
Contribution margin	500,000	1.1	550000

	Current Year	Projected year
Fixed Costs
Manufacturing overhead ($350,000 X .30)	105000	105000
Selling expenses ($250,000 X .60)	150000	150000
Administrative expenses ($270,000 X .80)	216000	216000
Total fixed costs	471000	471000

Compute the break-even point in units and sales dollars for the first year.

Unit selling price = $2,500,000 ÷ 100,000 = $25

Unit variable cost = $2000000 ÷ 100,000 = $20

Unit contribution margin = $25-20 = $5

Contribution margin ratio = $5 ÷ $25 = .20

		Break-even point in units
Break-even point in units=Fixed costs/Unit contribution margin	471000/4	119000
		Break-even point in dollars
Break-even point in dollars =Break-even point in units/Contribution margin ratio	471000/.20	2355000

The company has a target net income of $160,000. What is the required sales in dollars for the company to meet its target?
If the company meets its target net income number, by what percentage could its sales fall before it is operating at a loss? That is, what is its margin of safety ratio?

Sales dollars required for target net income

(Fixed costs + Target net income)/Contribution margin ratio

(471000+160000)/.20

3155000

Margin of safety ratio

= (Expected sales – Break-even sales) ÷ Expected sales

(3155000-2355000)/3155000

25.4%

The company is considering a purchase of equipment that would reduce its direct labor costs by $110,000 and would change its manufacturing overhead costs to 30% variable and 70% fixed (assume total manufacturing overhead cost is $350,000, as above). It is also considering switching to a pure commission basis for its sales staff. This would change selling expenses to 90% variable and 10% fixed (assume total selling expense is $250,000, as above). Compute (1) the contribution margin and (2) the contribution margin ratio, and recompute (3) the break-even point in sales

	Projected Year
Net sales	2,500,000
Variable costs
Direct materials	1,351,000
Direct labor ($250000 – $111000)	140000
Manufacturing overhead ($350,000 X .30)	105000
Selling expenses ($250,000 X .90)	225000
Administrative expenses ($270,000 X .20)	54000
Total variable costs	1,875,000
Contribution margin	625,000

Contribution margin ratio = $625000/2500000 = 25%

Break-even point in dollars = $486000 ÷ .25= $1,515,152 =1944000

Fixed cost
Manufacturing overhead ($350,000 X .70)	245000
Selling expenses ($250,000 X .10)	25000
Administrative expenses ($270,000 X .80)	216000
Total fixed costs	486000

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