Question

Case: Cost Structures for Global Shippers Inc. Management from Global Shippers Inc, an international shipping business, is in the process of assessing the choice between two different cost structures for the business Option A has relatively higher variable costs per unit shipped but lower annual fixed costs, while Option B has the opposite—relatively lower variable costs in its cost structure but higher fixed costs. Assume that delivery selling prices per unit are constant. The table below contains critical information in making the decision: Cost Informatie opie A B e 100 100 e colper delivered D W ed costs 1.450.00 0 .000 Management wants you to write a professional report, answering the following questions: Questions 1) What is the break-even point, in terms of volume (i.e., number of shipments per year), for Option A? Option B? (2) How many shipments would have to be made under Option A to produce operating income of $43,000 for an annual period? (3) How many shipments per month would have to be made under Option A to produce an annual operating margin equal to 11% of sales revenue? (4) How many shipments are required under Option B to produce net income of S213,000 per year, given a corporate tax rate of 25%? (5) Assume that for the coming year total fixed costs are expected to decrease by 8% for each of the two options. What is the new break-even point, in terms of number of shipments, for each option? By what percentage did the break-even point change for each case? How do these figures compare to the percentage increase in budgeted fixed costs? (6) Assume an average income tax rate of 35%. What volume (number of shipments) would be needed to generate net income of 8% of revenue for each option? (7) Which option do you think is the more profitable one for this business? Explain. (8) Which option do you consider to be more risky to the business? Explain (calculate degree of operating leverage to help answer this question).

Answer 1

1	Break Even Point = Total Fixed Costs / Contribution Per Unit
	Particulars	Option A	Option B
	Fixed Costs	$1,450,000	$4,700,000
	Contribution per Unit	$15	$40
	BEP (Volume)	96,667	117,500
2	How many shipments would have to be made under Option A to produce operating Income of $43,000 for an annual Period?
	Particulars	Option A
	Target Operating income	$43,000
	Fixed Costs	$1,450,000
	Total Amount to be recovered	$1,493,000
	Contribution per Unit	$15
	No. Of Shipments to be made ($1,493,000/$15)	99,533
3	How many shipments would have to be made under Option A to produce operating equal to 11% of Sales revenue ?
	Let the Number of Shipments be a
	Sales revenue = $100 X a
	Operating Income = $100a X 11% = $11a
	Operating income = Contribution - Fixed Costs
	$11a = $15a - $1,450,000
	$1,450,000 = $4a
	a = $1,450,000 / $4
	a = 362,500
	The total shipments to be made = 362,500
4.	How many shipments would have to be made under Option B to produce net Income of $213,000 per year, given a corporate tax rate of 25%
	Particulars	Option B
	Target net income	$213,000
	Tax @25% ($213,000*25/75)	$71,000
	Target income before tax	$284,000
	Fixed Costs	$4,700,000
	Total Amount to be recovered	$4,984,000
	Contribution per Unit	$40
	No. of Shipments to be made ($4,984,000/$40)	124,600

5	Assume that for the coming year total fixed costs are expected to decrease by 8% for each of the two options.
	What is the new break even point for each options
	Particulars	Option A	Option B
	Fixed Costs	1450000	4700000
	Future Fixed Costs	1334000	4324000
	Contribution per Unit	15	40
	BEP (Volume)	88933	108100
	Analysis
	Particulars	Option A	Option B
	BEP (Volume) - Current year	96667	117500
	BEP (Volume) - Future years	88933	108100
	Change in Break Even	7734	9400
	Decrease in Fixed Cost	8%	8%
	For 1% decrease in fixed costs, the break even point (volume) changes by 967 shipments(7734/8) in case of Option A and 1175 shipments(9400/8) in case of option B

6	Assume an average income tax rate is 35%. Wha volume (Shipments) would be needed to generate net income of 8% of revenue for each option?
	Let the number of shipments be a for option A and b for Option b
	Particulars	Option A	Option B
	Number of shipments	a	b
	Sales Revenue	$100a	$100b
	Net Income 8%	$8a	$8b
	Income before tax	$8a X 100 / 65	$8b X 100 / 65
	Contribution	$15a	$40b
	Total Fixed Costs	1450000	4700000
	Option A
	Operating income = Contribution - Fixed Costs
	$8a X 100/65 = $15a - $1,450,000
	$800a = 65 ($15a - $1,450,000)
	$800a = $975a - $94,250,000
	$175a = $94,250,000
	a= $94,250,000 / $175
	a = 538,571
	No.of shipments for Option A = 538,571
	Option B
	Operating income = Contribution - Fixed Costs
	$8b X 100/65 = $40b - $4,700,000
	$800b = 65 ($40b - $4,700,000)
	$800b = $2600b - $305,500,000
	$1800b = $305,500,000
	b= $305,500,000 / $1800
	b = 169,722 No.of shipments for Option B = 169,722