Cost Volume Profit Analysis

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Business Finance


Cost-Volume-Profit Analysis

Purpose of Assignment

The Case Study focuses on CVP (Cost-Volume-Profit), break-even, and margin of safety analyses which allows students to experience working through a business scenario and applying these tools in managerial decision making.

Assignment Steps

Resources: Generally Accepted Accounting Principles (GAAP), U.S. Securities and Exchange Commission (SEC)

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Scenario: Mary Willis is the advertising manager for Bargain Shoe Store. She is currently working on a major promotional campaign. Her ideas include the installation of a new lighting system and increased display space that will add $24,000 in fixed costs to the $270,000 in fixed costs currently spent. In addition, Mary is proposing a 5% price decrease ($40 to $38) will produce a 20% increase in sales volume (20,000 to 24,000). Variable costs will remain at $24 per pair of shoes. Management is impressed with Mary's ideas but concerned about the effects these changes will have on the break-even point and the margin of safety.

Complete the following:

  • Compute the current break-even point in units, and compare it to the break-even point in units if Mary's ideas are used.
  • Compute the margin of safety ratio for current operations and after Mary's changes are introduced (Round to nearest full percent).
  • Prepare a CVP (Cost-Volume-Profit) income statement for current operations and after Mary's changes are introduced.

Prepare a maximum 700-word informal memo to management addressing Mary's suggested changes.

  • Explain whether Mary's changes should be adopted. Why or why not? Analyze the above information (three bullet points above) and use this information to support your suggestion.

Show your work in Microsoft® Word or Excel®.

Complete calculations/computations using Microsoft® Word or Excel®.

Format your assignment consistent with APA guidelines.

Click the Assignment Files tab to submit your assignment.

Unformatted Attachment Preview

MEMO From: To: Bargain Shoe Store Manager Date: 5/25/2017 Subject: Cost-Volume-Profit Analysis I would like to review the proposed idea submitted by Mary Willis, the advertising manager for Bargain Shoe Store. Mary’s ideas was for installation of new lighting system and increased display space that will result in increase of fixed costs. Mary also proposes a decrease in the price of the product and suggests that the sales volume will increase by 20%. I have conducted a Cost-Volume-Profit Analysis to estimate the impact of the suggestions on the breakeven point and margin of safety of the company. A cost-volume-profit income statement is also prepared to ascertain the impact on the net income if the changes are introduced. Break-even Analysis Break even analysis is a financial tool used by the managers to determine the point at which a company will be able to cover its expenses and begin to make a profit. It takes into account the fixed costs, variable costs and selling price per unit and provides the number of units that are to be sold to cover all the expenses. The price per unit is determined by subtracting variable cost from selling price. Also the total fixed cost is divided by price per unit to determine the number of units for break-even. The calculation of break-even is given below. Break-even Point = Fixed Cost/Contribution Margin per Unit Selling Price Less Variable Cost Contribution Margin Current BEP $40.00 $24.00 $16.00 Mary's BEP $38.00 $24.00 $14.00 Change $2.00 $0.00 $2.00 Fixed Cost Break Even Point (Units) $270,000.00 16,875 $294,000.00 21,000 $24,000.00 4,125 The above calculation shows that the current break-even point is 16,875 units. If the changes suggested by Mary are introduced, the break-even point will increase to 21,000 units. This means that the company will have to sell 4,125 more units to break-even. The increase in break-even point is primarily due to increase in the fixed cost by $24,000 and decrease in the selling price by $2 per unit. Margin of Safety Margin of safety is the revenue that is earned by the business after paying the variable and fixed costs that are associated with the production of goods. It measures the amount of sale that is in excess of break-even point. The margin of safety at current state and if Mary’s changes are implemented are shown in the calculations below. Current Margin of Safety Units Actual Sales Less: Break Even Sales Margin of Safety Margin of Safety Ratio 20,000 16,875 3,125 Unit Price $40.00 $40.00 $40.00 15.63% Total $800,000.00 $675,000.00 $125,000.00 Mary's Changes Margin of Safety Units Actual Sales Less: Break Even Sales Margin of Safety Margin of Safety Ratio 24,000 21,000 3,000 Unit Price $38.00 $38.00 $38.00 12.50% Total $912,000.00 $798,000.00 $114,000.00 The current margin of safety is 15.63% and will decrease to 12.50% if Mary’s suggested changes are implemented. Therefore the margin of safety ratio will decrease if the changes suggested by Marry are introduced. CVP Income Statement A CVP income statement is prepared for internal organization use only. A CVP income statement the expenses are categorized either as fixed or as variable. The CVP income statement has been calculated and is shown below. Current Operations Sales Less: Variable Cost Contribution Margin Less: Fixed Cost Net Income Units 20,000 20,000 20,000 Price $40.00 $24.00 $16.00 Total $800,000.00 $480,000.00 $320,000.00 $270,000.00 $50,000.00 Units 24,000 24,000 24,000 Price $38.00 $24.00 $14.00 Total $912,000.00 $576,000.00 $336,000.00 $294,000.00 $42,000.00 Mary's Changes Sales Less: Variable Cost Contribution Margin Less: Fixed Cost Net Income The above income statements show that the current net income of the company is higher at $50,000. If Mary’s changes are introduced the net income will decrease to $42,000. It indicates that there will be decrease of $8,000 in net income, if Mary’s changes are introduced. The above discussion suggests that the Mary’s changes should not be adopted as it will result in increase in break-even point and decrease in margin of safety. The net income will also come down by $8,000. Thus, it is submitted, that the suggestion of Mary Willis should not be accepted. Answer a. BEP in Units = Fixed Cost / Contribution per Unit BEP in $ = Fixed Cost / Contribution Margin Ratio Conntribution Margin Ratio = Contribution / Sales Current Operations SP per Unit Variable Cost Contribution Per Unit 40 24 16 Marry's Recommendation 38 24 14 Contribution Margin Ratio 40.00% 36.84% Fixed Cost 294000 270000 BEP (in Units) 16,875 21000 BEP (in $) 675,000 798,000 Answer b. Margin of Safety Ratio = (Sales - BES) / Sales Current Operations Sales BEP (in $) Margin of Safety Margin of Safety Ratio 800000 675000 125000 16% Marry's Recommendation 912000 798000 114000 13% Answer c. Marry's Recommendation 20,000 24,000 40 38 Current Operations Sales In Units SP per Unit Sales Less: Variable Costs - $24 per Pair Contribution Less: Fixed Costs Net Operating Income 800,000 912,000 480,000 576,000 320,000 270,000 50,000 336,000 294,000 42,000 No, Changes should not be made. Net Income will decrease by $8,000 , if changes or Marry recommendation is Accepted
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Explanation & Answer

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The advertising manager of Bargain Shoe Store, Mary Willis, has had several ideas to
include the sales of the company. These ideas include both introducing a new lightning system to
increase the visibility of the shoes sold by the company and decreasing their price. The expected
outcome of such ideas is that the sales volume of the shoes will increase by 20%.
However, the management team of the company is concerned because the
implementation of such ideas would also increase the fixed costs and decrease the income from
sales. As a result, they believe that these ideas might affect the break-even point of the company
and the margin of safety and are thus reluctant to accept them unless an accurate cost-volume
profit analysis clearly demonstrates their viability.

Calculation of the current break-even point and the new one assuming Mary’s ideas were
The calculation of the break-even point enables the management team of the company to
know how many shoes they should sell to be able of covering both its fixed and variable
expenses. Thus, at the break-even point, the following equation applies:
𝐹+𝑉∗𝑄 = 𝑃∗𝑄
where F represents the fixed costs, V the variable costs for each unit, P the selling price of each
unit and Q the number of units (Drury, 2014).
Rearranging this equation, it is possible to estimate the number of units that the company
needs to sell to achieve the break-even point as:





According to the data provided, the selling price of each pair of shoes is of $40.00, the
variable expenses resulting from the manufacturing of each pair of shoes is of $24.00 and the
fixed expenses are of $270,000. The resulting current break-even point would then be:

𝑄𝑐𝑢𝑟𝑟𝑒𝑛𝑡 =

= 16,875 𝑝𝑎𝑖𝑟𝑠 𝑜𝑓 𝑠ℎ𝑜𝑒𝑠
40 − 24

On the other hand, the selling price of each pair of shoes would decrease to $38.00 and
the fixed costs would increase to $294,000 assuming that Mary’s ideas were implemented. The
resulting new break-even point would then be of 21,000, which re...

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