Question

CVP Analysis and Special Decisions

Smoothie Company produces fruit purees which it sells to smoothie bars and health clubs. Assume the most recent year’s sales revenue was $5,800,000. Variable costs were 55% of sales and fixed costs totaled $1,560,000. Smoothie is evaluating two alternatives designed to enhance profitability.

• One staff member has proposed that Smoothie purchase more automated processing equipment. This strategy would increase fixed costs by $250,000 but decrease variable costs to 50 percent of sales.
• Another staff member has suggested that Smoothie rely more on outsourcing for fruit processing. This would reduce fixed costs by $250,000 but increase variable costs to 60 percent of sales.

Round your answers to the nearest whole number.

(a) What is the current break-even point in sales dollars?
$Answer

(b) Assuming an income tax rate of 20 percent, what dollar sales volume is currently required to obtain an after-tax profit of $1,000,000?
$Answer

(c) In the absence of income taxes, at what sales volume will both alternatives (automation and outsourcing) provide the same profit?
$Answer

Answer 1

(a) Break even point in Sales Dollars = Fixed costs/Contribution Margin ratio

= $1,560,000 / 45% = $3,466,667 (appx.)

Here, contribution margin ratio = 100 -variable cost ratio

(b) before tax profit required

X-0.20X = $1,000,000

X= $1,250,000

Now, required sales = (fixed cost + desired profit)/ contribution margin ratio

= ($1,560,000 + $1,250,000)/ 45%

= $2,810,000 / 45% = $6,244,444

(c) let the sales volume be x

Profit of automation=profit on outsourcing

(1-.50)X-(1,560,000+250,000)=(1-.60)X-(1,560,000-250,000)

0.50x - $1,810,000 = 0.40x - $1,310,000

0.10x = $500,000

x = $5,000,000