Question

Mary’s Plants operates a large florist shop. Currently, the shop only sells one plant – the Venus Flytrap. Prices and costs are as follows:

Selling price Variable costs

Fly Trap $100 $60

Mary incurs $10,000 in monthly fixed costs related to the shop, and earns $15,000 in operating income per year.

What is Mary’s margin of safety, expressed in sales dollars, at her current sales level?

Answer 1

Current sales for earning $15,000 in a year = ( Yearly fixed costs + Required operating income ) / Contribution per unit

where, Contribution per unit = Selling price per unit - Variable costs per unit = $100 - $60 = $40 per unit.

Required operating income = $15,000.

Yearly fixed costs = $10,000 per month * 12 = $120,000.

Current sales = ( $120,000 + $15,000) / 40 = 3,375 units.

Margin of safety = Current sales - Breakeven sales

where, Break-even sales = Yearly fixed costs / Contribution per unit = $120,000 / $40 = 3,000 units.

Margin of safety in units = 3,375 units - 3,000 units = 375 units.

Margin of safety in dollars = Margin of safety in units * Selling price per unit = 375 * $100 = $37,500.