Chapter 3: Chapter 3

Cover Rugs is holding a 2 -week carpet sale at Josh's Club, a local warehouse store. Cover Rugs plans to sell carpets for 950 each. The company will purchase the carpets from a local distributor for 760each, with the privilege of returning any unsold units for a full refund. Josh's Club has offered Cover Rugs two payment alternatives for the use of space. Option 1: A fixed payment of \$7,410 for the sale period Option 2: 10 \% of total revenues earned during the sale period Assume Cover Rugs will incur no other costs. 1\. Calculate the breakeven point in units for (a) Option 1 and (b) Option 2 . 2\. At what level of revenues will Cover Rugs earn the same operating income under either option? a. For what range of unit sales will Cover Rugs prefer Option 1? b. For what range of unit sales will Cover Rugs prefer Option 2 ? 3\. Calculate the degree of operating leverage at sales of 65 units for the two rental options. 4\. Briefly explain and interpret your answer to requirement 3 .

Braided Rugs, Inc., is considering three possible countries for the sole manufacturing site of its newest area rug: Italy, Portugal, and Thailand. All area rugs are to be sold to retail outlets in the United States for \(\$ 250\) per unit. These retail outlets add their own markup when selling to final customers. Fixed costs and variable cost per unit (area rug) differ in the three countries. $$\begin{array}{lcccc} & & \text { Variable } & \text { Variable } \\\& \text { Sales Price } & \text { Annual } & \text { Manufacturing } & \text { Marketing \& } \\\\\text { to Retail } & \text { Fixed } & \text { cost per } & \text { Distribution cost } \\\\\text { Country } & \text { Outlets } & \text { costs } & \text { Area Rug } & \text { per Area Rug } \\\\\hline \text { Portugal } & \$ 250.00 & \$ 7,500,000 & \$ 45.00 & \$ 10.00 \\\\\text { Italy } & 250.00 & 5,000,000 & 65.00 & 15.00 \\\\\text { Thailand } & 250.00 & 9,000,000 & 55.00 & 20.00\end{array}$$

Chartz \(1-2-3\) is a top-selling electronic spreadsheet product Chartz is about to release version \(5.0 .\) It divides its customers into two groups: new customers and upgrade customers (those who previously purchased Chartz \(1-2-34.0\) or earlier versions). Although the same physical product is provided to each customer group, sizable differences exist in selling prices and variable marketing costs: $$\begin{array}{cccc} & \text { New Customers } & \text { Upgrade Customers } \\ \hline \text { Selling price } & & \$ 195 & \$ 115 \\\\\text { Variable costs } & & & \\\\\text { Manufacturing } & \$ 15 & & \$ 15 \\\\\text { Marketing } & 50 & 65 & 20 & 35 \\\\\text { Contribution margin } & & \$ 130 & & \$ 80 \\\\\hline\end{array}$$ The fixed costs of Chartz \(1-2-35.0\) are $\$ 16,500,000 .\( The planned sales mix in units is \)60 \%\( new customers and \)40 \%$ upgrade customers. 1\. What is the Chartz \(1-2-35.0\) breakeven point in units, assuming that the planned \(60 \% / 40 \%\) sales mix is attained? 2\. If the sales mix is attained, what is the operating income when 170,000 total units are sold? 3\. Show how the breakeven point in units changes with the following customer mixes: a. \(\mathrm{New} 40 \%\) and upgrade \(60 \%\) b. \(\mathrm{New} 80 \%\) and upgrade \(20 \%\) c. Comment on the results.

The Kenosha Company has three product lines of beer mugs \(-A, B,\) and \(\mathrm{C}-\) with contribution margins of \(\$ 5, \$ 4,\) and \(\$ 3,\) respectively. The president foresees sales of 175,000 units in the coming period, consisting of 25,000 units of \(A, 100,000\) units of \(B,\) and 50,000 units of \(C .\) The company's fixed costs for the period are \(\$ 351,000\) 1\. What is the company's breakeven point in units, assuming that the given sales mix is maintained? 2\. If the sales mix is maintained, what is the total contribution margin when 175,000 units are sold? What is the operating income? 3\. What would operating income be if the company sold 25,000 units of $A, 75,000\( units of \)B,\( and 75,000 units of \)C ?$ What is the new breakeven point in units if these relationships persist in the next period? 4\. Comparing the breakeven points in requirements 1 and 3 , is it always better for a company to choose the sales mix that yields the lower breakeven point? Explain.

Genesee Music Society is a not-for-profit organization that brings guest artists to the community's greater metropolitan area. The music society just bought a small concert hall in the center of town to house its performances. The lease payments on the concert hall are expected to be \(\$ 4,000\) per month. The organization pays its guest performers \(\$ 1,800\) per concert and anticipates corresponding ticket sales to be \(\$ 4,500\) per concert. The music society also incurs costs of approximately \(\$ 1,000\) per concert for marketing and advertising. The organization pays its artistic director $\$ 33,000\( per year and expects to receive \)\$ 30,000$ in donations in addition to its ticket sales. 1\. If the Genesee Music Society just breaks even, how many concerts does it hold? 2\. In addition to the organization's artistic director, the music society would like to hire a marketing director for \(\$ 25,500\) per year. What is the breakeven point? The music society anticipates that the addition of a marketing director would allow the organization to increase the number of concerts to 41 per year. What is the music society's operating income/(lloss) if it hires the new marketing director? 3\. The music society expects to receive a grant that would provide the organization with an additional \(\$ 17,000\) toward the payment of the marketing director's salary. What is the breakeven pointif the music society hires the marketing director and receives the grant?

Juicy Beauty manufactures and sells a face cream to small specialty stores in the greater Los Angeles area. It presents the monthly operating income statement shown here to George Lopez, a potential investor in the business. Help Mr. Lopez understand Juicy Beauty's cost structure. 1. Recast the income statement to emphasize contribution margin. 2\. Calculate the contribution margin percentage and breakeven point in units and revenues for June 2017 3\. What is the margin of safety (in units) for June \(2017 ?\) 4\. If sales in June were only 16,000 units and Juicy Beauty's tax rate is $30 \%$, calculate its net income.

Kindmart is an international retail store. Kindmart's managers are considering implementing a new business-to-business (B2B) information system for processing merchandise orders. The current system costs Kindmart $\$ 2,000,000\( per month and \)\$ 55$ per order. Kindmart has two options, a partially automated B2B and a fully automated B2B system. The partially automated B2B system will have a fixed cost of \(\$ 6,000,000\) per month and a variable cost of \(\$ 45\) per order. The fully automated B2B system has a fixed cost of \(\$ 14,000,000\) per month and a variable cost of \(\$ 25\) per order. Based on data from the past two years, Kindmart has determined the following distribution on monthly orders: $$\begin{array}{cc} \text { Monthly Number of Orders } & \text { Probability } \\ \hline 300,000 & 0.25 \\ 500,000 & 0.45 \\ 700,000 & 0.30 \end{array}$$ 1. Prepare a table showing the cost of each plan for each quantity of monthly orders. 2\. What is the expected cost of each plan? 3\. In addition to the information system's costs, what other factors should Kindmart consider before deciding to implement a new B2B system?

Lifetime Escapes generates average revenue of \(\$ 7,500\) per person on its 5-day package tours to wildlife parks in Kenya. The variable costs per person are as follows: $$\begin{array}{lr} \text { Airfare } & \$ 1,600 \\\\\text { Hotel accommodations } & 3,100 \\\\\text { Meals } & 600 \\\\\text { Ground transportation } & 300 \\\\\text { Park tickets and other costs } & 700 \\\\\text { Total } & \frac{11}{\$ 6,300}\end{array}$$ Annual fixed costs total \(\$ 570,000\) 1\. Calculate the number of package tours that must be sold to break even. 2\. Calculate the revenue needed to earn a target operating income of $\$ 102,000$. 3\. If fixed costs increase by \(\$ 19,000\), what decrease in variable cost per person must be achieved to maintain the breakeven point calculated in requirement \(1 ?\) 4\. The general manager at Lifetime Escapes proposes to increase the price of the package tour to \(\$ 8,200\) to decrease the breakeven point in units. Using information in the original problem, calculate the new breakeven point in units. What factors should the general manager consider before deciding to increase the price of the package tour?

Define contribution margin, contribution margin per unit, and contribution margin percentage.

Marketing Docs prepares marketing plans for growing businesses. For 2017, budgeted revenues are \ 1,500,000$ based on 500 marketing plans at an average rate per plan of 3,000 . The company would like to achieve a margin of safety percentage of at least 45 \% The company's current fixed costs are 400,000 and variable costs average 2,000 per marketing plan. (Consider each of the following separately. 1\. Calculate Marketing Docs' breakeven point and margin of safety in units. 2\. Which of the following changes would help Marketing Docs achieve its desired margin of safety? a. The average revenue per customer increases to 4,000 b. The planned number of marketing plans prepared increases by 5 \% c. Marketing Docs purchases new software that results in a 5 \% increase to fixed costs but reduces variable costs by 10 \% per marketing plan.