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Financial & Managerial Accounting
Found in: Page 844
Financial & Managerial Accounting

Financial & Managerial Accounting

Book edition 7th
Author(s) John J Wild, Ken W. Shaw, Barbara Chiappetta
Pages 1096 pages
ISBN 9781259726705

Short Answer

This year Best Company earned a disappointing 5.6% after-tax return on sales (net income/sales) from marketing 100,000 units of its only product. The company buys its product in bulk and repackages it for resale at the price of $20 per unit. Best incurred the following costs this year

Total variable unit costs

$800,000

Total variable packaging costs

$100,000

Fixed costs

$950,000

Income tax rate

25%

The marketing manager claims that next year’s results will be the same as this year’s unless some changes are made. The manager predicts the company can increase the number of units sold by 80% if it reduces the selling price by 20% and upgrades the packaging. This change would increase variable packaging costs by 20%. Increased sales would allow the company to take advantage of a 25% quantity purchase discount on the cost of the bulk product. Neither the packaging change nor the volume discount would affect fixed costs, which provide an annual output capacity of 200,000 units.

Required

1. Compute the break-even point in dollar sales under the (a) existing business strategy and (b) new strategy that alters both unit selling price and variable costs. (Round answers to the next whole dollar.)

2. Prepare a forecasted contribution margin income statement with two columns showing the expected results of (a) the existing strategy and (b) changing to the new strategy. The statements should report sales, total variable costs (unit and packaging), contribution margin, fixed costs, income before taxes, income taxes, and net income. Also, determine the after-tax return on sales for these two strategies.

  1. Break-even dollar sales:

Existing strategy: $1,727,273

New strategy: $1,727,273

  1. Net income:

Existing strategy: $112,500

New strategy: $475,500

See the step by step solution

Step by Step Solution

Step 1: Definition of Contribution Margin

The line item representing the sales revenue generated over the variable cost incurred in the production process is known as the contribution margin. Variable cost includes expenses relating to labor and material.

Step 2: Break-even point for both business strategy

(a) Existing business strategy

Calculation of variable cost per unit:

Particular

Amount $

/

Units

=

Per unit

Total variable unit costs

$800,000

/

100,000

=

$8

Total variable packaging costs

$100,000

/

100,000

=

$1

$9

Calculation of contribution margin ratio:

Break-even dollar sales:

(b) New business strategy:

Calculation of new variable cost:

Particular

Amount $

/

Units

X

Percentage after increase or decrease

=

Per unit

Total variable unit costs

$800,000

/

100,000

X

75%

=

$6

Total variable packaging costs

$100,000

/

100,000

X

120%

=

$1.2

X

$7.2

Calculation of contribution margin ratio:

Break-even dollar sales:

Step 3: Contribution margin income statement for each strategy

Particular

Existing strategy

New strategy

Sales

$2,000,000

$2,880,000

Less: Variable cost

(900,000)

(1,296,000)

Contribution margin

1,100,000

1,584,000

Less: Fixed cost

(950,000)

(950,000)

Pre-tax income

150,000

634,000

Less: Income tax

(37,500)

(158,500)

Net income

$112,500

$475,500

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