CVP RELATIONSHIPS Chapter 5 Connect Homework

QUESTION ONE Pittman Company is a small but growing manufacturer of telecommunications equipment. The company has no sales force of its own; rather, it relies completely on independent sales agents to market its products. These agents are paid a sales commission of 15% for all items sold. Barbra Cheney, Pittman’s controller, has just prepared the company’s budgeted income statement for next year. The statement as follows:

(Figure 1 on next slide) As Barbara handed the statement to Karl Vecci, Pitman’s President, she commented, “I went ahead and used the agents’ 15% commission rate in completing these statements, but we’ve just learned that they refuse to handle our products next year unless we increase the commission rate to 20%.”

“That’s the last straw,” Karl replied angrily. “Those agents have been demanding more and more, and this time they’ve gone too far. How can they possibly defend a 20% commission rate?”

“They claim that after paying for advertising, travel, and other costs of promotion, there’s nothing left over for profit,” replied Barbara.

“It’s just plain robbery,” retorted Karl. “And I also say it’s time we dumped those guys and got our own sales force. Can you get your people to work up some cost figures for us to look at?”

“We’ve already worked them up,” said Barbara. “Several companies we know about pay a 7.5% commission to their own salespeople, along with a small salary. Of course, we would have to handle all promotion costs, too. We figure our fixed expenses would increase by $3080000 per year, but that would be more than offset by the $4560000 (20%* $22880000) that we would avoid on agents’ commissions.” The breakdown of the $3080000 cost follows:

(Figure 2 on next slide) “Super,” replied Karl. “And I noticed that the $3420000 is just what we're paying the agents under the old 15% commission rate.”

“It’s even better than that,” explained Barbara. “We can actually save $245000 a year because that what were having to pay the auditing firm now to check out the agents’ reports. So our overall administrative expenses would be less.”

“Pull all of these numbers together and we’ll show them to the executive committee tomorrow,” said Karl. “With the approval of the committee, we can move on the matter immediately.”

FIGURE ONEPittman Company

Budgeted Income StatementFor the Year Ended December 31

Sales $20000000Manufacturing Expenses:Variable $9000000Fixed Overhead 2440000 11440000Gross Margin 8560000Selling and Administrative Expenses:

Commissions to agents 3000000Fixed Marketing Expenses 220000*Fixed Administrative Expenses 1900000 5120000Net Operating Income 3440000Fixed Interest Expenses 990000Income before income taxes 2450000Income Taxes (20%) 490000Net Income 1960000

*Primarily depreciation on storage facilities

FIGURE TWOSalaries:Sales Manager $200000Salespersons 700000Travel and Entertainment 500000Advertising 1400000Total 2800000

QUESTIONS REGARDING 15% COMMISSIONIncome Statement at 15% CommissionSales 20000000 100%Less Variable ExpensesManufacturing 9000000Commissions (15%) 3000000Total Variable Expenses 12000000 60%Contribution Margin 8000000 40%Less Fixed ExpensesOverhead 2440000Marketing 220000Administrative 1900000Interest 990000Total Fixed Expenses 5550000Income before Taxes 2450000Income Taxes (20%) 490000Net Income 1960000

QUESTIONS REGARDING 15% COMMISSION Break even in Dollar Sales= Fixed Expenses/CM 5550000/.4= $13875000

Operating Leverage= CM/Net Income 8000000/2450000= 3.27

QUESTION REGARDING 20% COMMISSIONIncome Statement at 15% Commission

Sales 20000000 100%Less Variable ExpensesManufacturing 9000000Commissions (20%) 4000000Total Variable Expenses 13000000 65%Contribution Margin 7000000 35%Less Fixed ExpensesOverhead 2440000Marketing 220000Administrative 1900000Interest 990000Total Fixed Expenses 5550000Income before Taxes 1450000Income Taxes (20%) 290000Net Income 1160000

QUESTIONS REGARDING 20% COMMISSION Break even in Dollar Sales= Fixed Expenses/CM Ratio 5550000/.35= $15857143

Want to generate $1325000 in income before taxes Dollar sales to attain target= (Fixed Expenses+ Target)/CM Ratio (5550000+1325000)/.35= $19642857

Degree of Operating Leverage= CM/Net Income 7000000/1450000= 4.83

QUESTIONS REGARDING OWN SALES FORCE Income Statement at 15% Commission

Sales 20000000 100%Less Variable ExpensesManufacturing 9000000Commissions (7.5%) 1500000Total Variable Expenses 10500000 52.5%Contribution Margin 9500000 47.5%Less Fixed ExpensesOverhead 2440000Marketing 3020000 (220000+2800000)Administrative 1725000 (1900000-175000)Interest 990000Total Fixed Expenses 8175000Income before Taxes 1325000Income Taxes (20%) 265000Net Income 1060000

QUESTIONS REGARDING OWN SALES FORCE Break Even in Dollar sales= Fixed Expenses/CM ratio 8175000/.45= $17210526

Degree of Operating Leverage= CM/Net Income 9500000/1325000= 7.17

QUESTION TWO Whirly Corporation’s most recent income statement is shown below: Total Per UnitSales (7400 units) $236800 $32Variable Expenses 140600 19Contribution Margin 96200 13Fixed Expenses 54100Net Operating Income

42100

Prepare a new contribution format income statement under each of the following conditions (consider each case independently):

1. The sales volume increases by 90 units7400+90= 7490Sales= (7490)(32)= 239680Variable expenses= (7490)(19)= 142310

Whirly CorporationContribution Income Statement

Total Per UnitSales 239680 32Variable Expenses 142310 19Contribution Margin 97370 13Fixed Expenses 54100Net Operating Income

43270

2. The sales volume decreases by 90 units. 7400-90= 7310 Sales= (7310)(32)= 233920 Variable expenses= (7310)(19)= 138890

Whirly CorporationContribution Income Statement

Total Per UnitSales 233920 32Variable Expenses 138890 19Contribution Margin 95030 13Fixed Expenses 54100Net Operating Income

40930

3. The sales volume is 6400 units. Sales= (6400)(32)= 204800 Variable Expenses= (6400)(19)= 121600

Whirly CorporationContribution Income Statement

Total Per UnitSales 204800 32Variable Expenses 121600 19Contribution Margin 83200 13Fixed Expenses 54100 13Net Operating Income

29100

QUESTION THREE Lin Corporation has a single product whose selling price is $136 and whose variable expenses is $68 per unit. The company’s monthly fixed expense is $31650.

Using the equation method, determine for the unit sales that are required to earn a target profit of $5750.

Unit sales to attain a target profit= (target profit+ Fixed expenses)/unit CM

Unit CM= selling price per unit- variable expense per unit (5750+31650)/(136-68)= 550

QUESTION FOUR Lin Corporation has a single product whose selling price is $136 and whose variable expenses is $68 per unit. The company’s monthly fixed expense is $31650.

Using the formula method, determine for the unit sales that are required to earn a target profit of $9900.

(9900+31650)/(136-68)= 611

QUESTION FIVE Engberg Company installs lawn sod in home yards. The company’s most recent monthly contribution format income statement follows:

Amount Percent of SalesSales $124000 100%Variable Expenses 49600 40%Contribution Margin 74400 60%Fixed Expenses 21000Net Operating Income

$53400

1. Compute the company’s degree of operating leverage. CM/Net operating Income 74400/53400= 1.39 2. Using the degree of operating leverage, estimate the impact on net operating income of a 27% increase in sales.

Percentage change in Net Operating Income= (Degree of Operating Leverage)(Percentage change in sales)

(1.39)(27)= increases by 37.53% 3. Construct a new contribution format income statement for the company assuming a 27% increase in sales.

Sales (124000)(27%) 157480Variable Expenses 62992Contribution Margin 94488Fixed Expenses 21000Net Operating Income 73488

QUESTION SIX Last month when Holiday Creation, Inc., sold 43000 units, total sales were $295000, total variable expenses were $247800, and fixed expenses were $38200.

1. What is the company’s contribution margin (CM) ratio? (295000-247800)/295000= .16

2. Estimate the change in the company’s net operating income if it were to increase its total sales by $2300.

(2300)(.16)= $368 (Change in total sales)(cm ratio)= change in net operating income

QUESTION SEVEN Mauro Products distributes a single product, a woven basket whose selling price is $28 and whose variable expense is $23.24 per unit. The company’s monthly fixed expense is $5,236.

1. Solve for the company’s break even point in unit sales using the equation method.

Profit= (unit cm)(Q)- Fixed Expenses 0= (28-23.24)Q-5236 Q= 1200

QUESTION SEVEN (CONT.) 2. Solve for the company’s break-even point in dollar sales using the equation method and the CM ratio.

CM Ratio= (sales-variable expenses)/sales (28-23.24)/28= .17 or 17% Profit= (cm ratio)(sales)- Fixed Expenses 0= (.17)(sales)- 5236 Break even point in dollar Sales= 30800

CONT. 3. Solve for the company’s break-even point in unit sales using the formula method.

Unit sales to Break even= Fixed Expenses/ unit Cm Unit CM= sales price per unit- variable expenses per unit Unit Cm= 28-23.24= 4.76 Unit sales to Break even= 5236/4.76= 1100 4. Solve for the company’s break-even point in dollar sales using the formula method and the CM ratio.

Dollar sales to Break Even= Fixed Expenses/ CM Ratio CM Ratio= (sales- variable expenses)/ Sales CM Ratio= (28-23.24)/28= .17 or 17% Dollar sales to Break Even= 5236/.17= 30800

QUESTION EIGHTMolander Corporation is a distributor of a sun umbrella used at resort hotels. Data concerning the next month’s budget appear below:

1. Compute the company’s margin of safety

Margin of safety in dollars= total budgeted (actual) sales- Break Even SalesBreak even sales in dollars= Fixed expenses/CM RatioCm ratio= (sales-variable expenses)/salesCm ratio= (30-14)/30= .53333Break even in dollar sales= 13760/.53333= 25800Sales (at current sale unit) =(30)(1010)= 30300Margin of safety in dollars= 30300-25800= 4500

Selling Price $30 per unitVariable Expenses $14 per monthFixed Expenses $13760 per monthUnit sales 1010 units per month

2. Compute the company’s margin of safety as a percentage of its sales. Margin of safety percentage= Margin of safety in dollars/salesMargin of safety in dollars= 4500 *see previous slideMargin of safety percentage= 4500/30300= 14.85%

QUESTION NINE Data for Hermann Corporation are shown below:

Fixed Expenses are $72000 per month and the company is selling 4200 units per month.

Per Unit Percent of SalesSelling Price 60 100%Variable Expenses 39 65%Contribution margin 21 35%

1a. The marketing manager argues that a $9600 increase in the monthly advertising budget would increase monthly sales by $23000. Calculate the increase or decrease in net operating income.

* (23000+252000)= 275000 **(9600+72000)= 81600 ***(275000/4200)= 65.4761 (sales price per unit)(65.4761)(65%)= 42.55952381 (variable price per unit)(42.55952381)(4200)= 17875014650-16200= decrease by $1550 Should the advertising budget be increased? No

Current Sales Sales with Advertising Budget

Sales 252000 *275000Variable Expenses 163800 ***178750Contribution margin 88200 96250Fixed Expenses 72000 **81600Net Operating Income 16200 14650

QUESTION TEN Refer to the data in Question Nine. Management is considering using higher-quality components that would increase the variable expense by $4 per unit. The marketing manager believes that the higher-quality product would increase sales by 25% per month. Calculate the change in total contribution margin.

*(4200)(.25)= 1050, (1050+4200)= 5250 (5250)(60)= 315000 ** (39+4)= 43, (43)(5250)= 225750 89250-88200= increase by $1050 Should the higher-quality components be used? Yes

Current Sales

Sales with changes

Sales 252000 *315000Variable Expenses 163800 **225750Contribution Margin 88200 89250