Question

The condensed income statement for the Terry and Jerry partnership for 2016 is as follows:

Terry and Jerry Company Income Statement For the Year Ended December 31, 2016
Sales (200,000 units)		$1,200,000
Cost of goods sold		800,000
Gross profit		400,000
Operating expenses
Selling	$280,000
Administrative	160,000	440,000
Net Loss		($40,000)

A cost behavior analysis indicates that 75% of the costs of goods sold are variable, 50% of the selling expenses are variable, and 25% of the administrative expenses are variable.

Questions

(a) Compute the break-even point in total sales dollars and in units for 2016.

(b) Terry has proposed a plan to get the partnership “out of the red” and improve its profitability. She feels that the quality of the product could be substantially improved by spending $0.25 more per unit on better raw materials. The selling price per unit could be increased to only $6.25 because of competitive pressures. Terry estimates that sales volume will increase by 30%. What effect would Terry’s plan have on the profits and the break-even point in dollars of the partnership? (round the contribution margin ratio to two decimal places.)

(c) Jerry was a marketing major in college. She believes that sales volume can be increased only by intensive advertising and promotional campaigns. She therefore proposed the following plan as an alternative to Terry’s. (1) Increase variable selling expenses to $0.79 per unit, (2) lower the selling price per unit by $0.30, and (3) increase fixed selling expenses by $35,000. Jerry quoted an old marketing research report that said that sales volume would increase by 60% if these changes were made. What effect would Jerry’s plan have on the profits and the break-even point in dollars of the partnership?

(d) Which plan should be accepted? Explain your answer.

(e) Terry has another trading business that is expecting to sell 1,250 units of products at $12 per unit, and break-even sales for the product are $12,000.

(i) What is the margin of safety ratio?

(ii) What does this ratio mean to this business?

Answer 1

a) BREAK EVEN POINT

Break Even Point (Units) = Fixed Costs/ (sellling price P.u-Variable cost P.u)

= 4,60,000/(6-3.9) = 2,19,048 Units

Break Even Point ( in Dollars) = Fixed Costs/contibution Margin*

= 4,60,000/35% = $ 13,14,286 /-

*Contribution Margin = (6-3.9)/6 = 35%

b) Terry's Plan

Selling Price Increases from $6 to $6.25 and Sales Volume increases from 2,00,000 to 2,60,000 units

Effect on profits

Sales = $16,25,000 (260000 units * 6.25)

COGS = $8,00,000

Gross Profit = $8,25,000

Operating Exp = $4,40,000

Additional Exp

for better RM = $65,000(2,60,000*0.25)

Net Profit = $3,20,000

Therefore, there is a shift in operations from a Net Loss of $40,000 to Net Profit of $3,20,000

Effect on BEP

Break Even Point ( in Dollars) = Fixed Costs/contibution Margin*

= 4,60,000/33.6%  = $13,69,048 /-

*contribution Margin = (6.25-4.15)/6.25 = 33.6%

BEP ( in Dollars) has Increased from $13,14,286 to $13,69,048

c) Jerry's Plan

Selling Price decreases from $6 to $5.7 and Sales Volume increases from 2,00,000 to 3,20,000 units

Effect on profits

Sales = $18,24,000 (320000 units * $5.7)

COGS = $8,00,000

Gross Profit = $10,24,000

Operating Exp = $4,40,000

Additional ADV Exp = $2,52,800(3,20,000*0.79)

Additional Fixed Exp = $35,000

Net Profit = $2,96,200

Therefore, there is a shift in operations from a Net Loss of $40,000 to Net profit of $2,96,200

Effect on BEP

Break Even Point ( in Dollars) = Fixed Costs/contibution Margin*

= 4,95,000/17.72%  = $27,93,454 /-

*contribution Margin = (5.7-4.69)/5.7 = 17.72%

BEP ( in Dollars) has Increased from $13,14,286 to $27,93,454

d) RECOMMENDED PLAN

Terry's Plan was Recommended Because Profit under such plan is More than Terry's plan & Break Even In Terry's Plan is Easily acheivable

e) Terry's Another Business

i) Margin of Safety Ratio

MOS Ratio = (current sales level - Break even sales)/current sales level

= [(1250*12)-12000]/(1250*12)

= 20%

ii) MOS Ratio Means that level which is Over & Above the Break Even Level. If a company has Achieved this Ratio than the company has only Profits.