16-2: Doyle's Candy Company

a. Break-even volume = Fixed costs / Unit contribution

= $1,056,000 / $9.60 - $5.76
= $1,056,000 / $3.84 = 275,000 boxes
b. Current contribution margin percentage = $3.84 / $9.60 = 40%. In general, abbreviating contribution
margin percentage as CMP, we have:

CMP

UR UVC
UR

Solving for UR, this becomes:

UR

UVC
1 CMP

With a l5% increase in variable production costs (to $5.52, giving total UVC of $6.48), the selling price
per box is:

UR

$6.48 $6.48

$10.80
1 .40
.60

c. Projected income statement:

Revenues (390,000 x $9.60) ...............................................................................................................................................

$3,744,000
Variable costs (390,000 x $5.76) ........................................................................................................................................
2,246,400
Contribution ........................................................................................................................................................................
1,497,600
Fixed costs ..........................................................................................................................................................................
1,056,000
Income before tax ...............................................................................................................................................................
441,600
Taxes (40%) ........................................................................................................................................................................
176,640
Net income after tax .......................................................................................................................................................
$ 264,960
In general, pretax I = (UR - UVC) X - TFC. So in this case:
441,600
$3.12 X
X
TR

=
=
=
=

($9.60 6.48) X - 1,056,000

$1,497,600
480,000 boxes
480,000 @ $9.60 = $4,608,000

(Note that as long as the tax rate remains constant, it is irrelevant in answering this question.)

16-3: Mike Solid's Pizzeria

a. Assuming that cost of food sold is the only item of variable expense, then:

Break even volume

Fixed Costs
Unit Contribution
$241,360 $92,400 $148,960

$5.95
$8.50 $2.55*

= 25,035 pizzas
*$308,000 / $8.50 = 36,235 pizzas: $92,400 / 36,235 = $2.55 per pizza variable costs.

Cash fixed costs = total fixed costs - depreciation = $148,960 - ($16,000 + $8,000) = $124,960.
However, the depreciation tax shield ($24,000 x 30%) offsets $7,200 of these fixed costs, leaving
$117,760 net cash fixed costs. Break-even volume, on a cash basis, then, is $117,760 $5.95 = 19,792
pizzas.

 Cash generated by operations equals net income plus noncash expenses (here, only depreciation)
$46,648 + $24,000 = $70,648, leaving $56,248 if Calderone withdraws $14,400 for his personal use.
The easiest way to approach this question is to treat the target pretax income as a fixed cost. Since the
target income is $60,000, the target pretax income is $60,000 70% = $85,713. Adding this to the
$148,960 fixed costs gives a total of $234,673. So the required volume = $234,673 / $5.95 = 39,441
pizzas.
Most of the expenses are fixed. Therefore a large volume of sales is required before any profit is made.
Once this point is reached (break-even), each sale contributes $5.95 to profits, a larger change in profits
since profits begin at zero at this point while the $8.50 change in sales is a smaller proportion of sales
because of the large amount of sales required to reach the break-even point.
The cash flow from operations will exceed his profits because $24,000 of the expense (depreciation) is
not a current cash-consuming cost.
************************

Brief Examples: Bomp Ltd.

Bomp Ltd. produces a chocolate almond bar. Each bar sells for Rs. 20. The variable
cost for each bar (sugar, chocolate, almonds, wrapper, labour) total Rs. 12.50. The
total fixed cost is Rs. 30,00,000. During the year, 10,00,000 bars were sold. The
CEO of Bomp Ltd. not fully satisfied with the profit performance of chocolate bar,
was considering the following options to increase the profitability:
(I) Increase advertising
(II) Improve the quality of ingredients and, simultaneously, increase the selling price
(III) Increase the selling price
(IV) Combination of three
Required:
(1) The sales manager is confident that an advertising campaign could double sales
volume. If the company CEO's goal is to increase this year's profits by 50% over last
year's, what is the maximum amount that can be spent on advertising.
(2) Assume that the company improves the quality of its ingredients, thus increasing
variable cost to Rs.15. Answer the following questions:
(a) How much the selling price be increased to maintain the same break-even point?
(b) What will be the new price, if the company wants to increase the old contribution
margin ratio by 50%?
(3) The company has decided to increase its selling price to Rs. 25. The sales volume
drops from 10,00,000 to 8,00,000 bars. Was the decision to increase the price a good
one? Compute the sales volume that would be needed at the new price for the
company to earn the same profit at last year.
(4) The sales manager is convinced that by improving the quality of ingredients
(increasing variable cost to Rs. 15) and by advertising the improved quality

(advertisement amount would be increased by Rs. 50,00,000), sales volume could be

doubled. He has also indicated that a price increase would not affect the ability to
double sales volume as long as the price increase is not more than 20% of the current
selling price. Compute the selling price that would be needed to achieve the goal of
increasing profits by 50%. Is the sales manager's plan feasible? What selling price
would you choose? Why?

Brief Examples:
A Company manufactures a single product with a capacity of 1,50,000 units per
annum. The summarized profitability statement for the year is as under:

Required
What will be the amount of sales required to earn a target profit of 25% on
sales, if the packing is improved at a cost of Re.l per unit?
There is an offer from a large retailer for purchasing 30,000 units per annum,
subject to providing a packing with a different brand name at a cost of Rs. 2
per unit. However, in this case there will be no selling and distribution
expenses. Also this will not, in any way, affect the company's existing
business. What be the break-even price for this additional offer.?
If an expenditure of Rs. 3,00,000 is made on advertising the sales would
increase from the present level of l,oo,ooo units to 1,20,000 units at a price of
Rs. 18 per unit, will that expenditure be justified?
If the selling price is reduced by Rs. 2 per unit, there will be 100% capacity
utilization. Will the reduction in selling price be justified?