Chapter 3: Chapter 3

Once a company exceeds its breakeven level, operating income can be calculated by multiplying: a. The sales price by unit sales in excess of breakeven units. b. Unit sales by the difference between the sales price and fixed cost per unit. c. The contribution margin ratio by the difference between unit sales and breakeven sales. d. The contribution margin per unit by the difference between unit sales and breakeven sales.

Fill in the blanks for each of the following independent cases. $$\begin{array}{cccccc} & & \text { Variable } & & & \text { Operating } & \text { Contribution } \\\\\text { Case } & \text { Revenues } & \text { costs } & \text { Fixed costs } & \text { Total costs } & \text { Income} & \text { Margin Percentage } \\\\\hline \text { a. } & & \$ 600 & & \$ 800 & \$ 1,600 & \\\\\text { b. } & \$ 2,500 & & \$ 200 & & \$ 900 & \\\\\text { c. } & \$ 500 & \$ 300 & & \$ 500 & & \\\\\text { d. } & \$ 1,200 & & \$ 200 & & & 25 \%\end{array}$$

Garrett Manufacturing sold 410,000 units of its product for \(\$ 68\) per unit in 2017 Variable cost per unit is \(\$ 60,\) and total fixed costs are $\$ 1,640,000$ 1\. Calculate (a) contribution margin and (b) operating income. 2\. Garrett's current manufacturing process is labor intensive. Kate Schoenen, Garrett's production manager, has proposed investing in state-of-the-art manufacturing equipment, which will increase the annual fixed costs to $\$ 5,330,000\(. The variable costs are expected to decrease to \)\$ 54$ per unit. Garrett expects to maintain the same sales volume and selling price next year. How would acceptance of Schoenen's proposal affect your answers to (a) and (b) in requirement 1? 3\. Should Garrett accept Schoenen's proposal? Explain.

The Deli-Sub Shop owns and operates six stores in and around Minneapolis. You are given the following corporate budget data for next year: $$\begin{array}{lr}\text { Revenues } & \$ 11,000,000 \\\\\text { Fixed costs } & \$ 3,000,000 \\\\\text { Variable costs } & \$ 7,500,000\end{array}$$ Variable costs change based on the number of subs sold. Compute the budgeted operating income for each of the following deviations from the original budget data. (Consider each case independently.) 1\. \(A 10 \%\) increase in contribution margin, holding revenues constant 2\. \(A\) 10 \(\%\) decrease in contribution margin, holding revenues constant 3\. \(A 5 \%\) increase in fixed costs 4\. \(A\) 5\% decrease in fixed costs 5\. A \(5 \%\) increase in units sold 6\. \(A 5 \%\) decrease in units sold 7\. \(A 10 \%\) increase in fixed costs and a \(10 \%\) increase in units sold 8\. \(A 5 \%\) increase in fixed costs and a \(5 \%\) decrease in variable costs 9\. Which of these alternatives yields the highest budgeted operating income? Explain why this is the case.

The Doral Company manufactures and sells pens. Currently, 5,000,000 units are sold per year at \(\$ 0.50\) per unit. Fixed costs are \(\$ 900,000\) per year. Variable costs are \(\$ 0.30\) per unit. Consider each case separately: 1\. a. What is the current annual operating income? b. What is the current breakeven point in revenues? Compute the new operating income for each of the following changes: 2\. A \$0.04 per unit increase in variable costs 3\. \(A \cdot 10 \%\) increase in fixed costs and a \(10 \%\) increase in units sold 4\. \(A\) 20 \(\%\) decrease in fixed costs, a \(20 \%\) decrease in selling price, a \(10 \%\) decrease in variable cost per unit, and a \(40 \%\) increase in units sold Compute the new breakeven point in units for each of the following changes: 5\. \(A 10 \%\) increase in fixed costs 6\. \(A 10 \%\) increase in selling price and a \(\$ 20,000\) increase in fixed costs

Westover Motors is a small car dealership. 0 n average, it sells a car for 32,000, which it purchases from the manufacturer for 28,000 .Each month, Westover Motors pays 53,700 in rent and utilities and 69,000 for salespeople's salaries. In addition to their salaries, salespeople are paid a commission of 400 for each car they sell. Westover Motors also spends 10,500 each month for local advertisements. Its tax rate is 40 \% 1\. How many cars must Westover Motors sell each month to break even? 2\. Westover Motors has a target monthly net income of 69,120 .What is its target monthly operating income? How many cars must be sold each month to reach the target monthly net income of 69,120 ?

The Home Style Eats has two restaurants that are open 24 hours a day. Fixed costs for the two restaurants together total 430,500per year. Service varies from a cup of coffee to full meals. The average sales check per customer is 8.75 .The average cost of food and other variable costs for each customer is 3.50 . The income tax rate is 36 \% .Target net income is 117,600. 1. Compute the revenues needed to earn the target net income. 2\. How many customers are needed to break even? To earn net income of $\$ 117,600 ?$ 3\. Compute net income if the number of customers is 170,000 .

Perfect Fit Jeans Co. sells blue jeans wholesale to major retailers across the country. Each pair of jeans has a selling price of \(\$ 50\) with \(\$ 35\) in variable costs of goods sold. The company has fixed manufacturing costs of $\$ 2,250,000\( and fixed marketing costs of \)\$ 250,000 .$ Sales commissions are paid to the wholesale sales reps at \(10 \%\) of revenues. The company has an income tax rate of \(20 \%\) 1\. How many jeans must Perfect Fit sell in order to break even? 2\. How many jeans must the company sell in order to reach: a. a target operating income of \(\$ 420,000 ?\) b. a net income of \(\$ 420,000 ?\) 3\. How many jeans would Perfect Fit have to sell to earn the net income in requirement 2b if: (Consider each requirement independently.) a. the contribution margin per unit increases by \(10 \%\) b. the selling price is increased to \(\$ 51.50\) c. the company outsources manufacturing to an overseas company increasing variable costs per unit by 2.00 and saving 70 of fixed manufacturing costs.

Suppose Morrison Corp.'s breakeven point is revenues of \(\$ 1,100,000\) Fixed costs are \(\$ 660,000\) 1\. Compute the contribution margin percentage. 2\. Compute the selling price if variable costs are \(\$ 16\) per unit 3\. Suppose 75,000 units are sold. Compute the margin of safety in units and dollars. 4\. What does this tell you about the risk of Morrison making a loss? What are the most likely reasons for this risk to increase?

Distinguish between operating income and net income.