Question

The Great Tamale Alternative 1- Food Truck After experiencing such great success with their food cart, Nathan and Cody are considering purchasing a food truck to serve other communities. This would allow the Great Tamale, GT, to reach even more customers in different geographic locations. There would be an increase in the selling price per plate. There will also be an increase in the fixed costs of $30,000 for advertising to inform the public of this change (this amount is already included below under Food Truck data). The financial information is presented below for this alternative as well as the original data. Assume 31,125 plates are sold for the food cart and 45,625 plates are sold for the food truck.

	Food Cart	Food Truck
Sales	$ 217,875.00	$ 365,000.00
Variable cost	46,687.50	103,437.50
Contributuion margin	171,187.50	261,562.50
Fixed Cost	90,000.00	147,500.00
Income Before Taxes	81,187.50	114062.50
income Taxes (32% rate) net income	25,980.00 $55,207.50	36,500.00 $77,562.50

Required:

1.) Compute the company's contribution margin under both scenarios, if GT decides to remain a regular food cart and if they decide to become a food truck. Compute the contribution margin both in total dollars and per unit

2.) Compute the company's contribution margin ratio under both scenarios. (Note: Do not round the CMR for accurate calculations in the following questions).

3.) Compute the break-even point in sales dollars under each scenario. How many plates will need to be sold under each situation to break-even?

4.) Compute the operating leverage under each scenario. What does this figure mean? Why is it important to management?

5.) If the company wishes each scenario, food cart and food truck, to generate net income (after-tax) of $170,000, what is the amount of sales that needs to be generated? How many plates will then need to be sold? Prepare a contribution margin statement for this step and verify that your after-tax net income in fact equals $170,000 for both the food cart and food truck.

6.) Assume that the company expects sales to decline by 20% next year. There will be no change in plate price. Prepare forecasted financial results for next year following the format of the contribution margin income statement as shown above with columns for each of the two types (assume a 32% tax rate, and that any loss before taxes yields a 32% tax savings).

7.) Assume that the company expects sales to increase by 20% next year. There will be no change in plate price. Prepare forecasted financial results for next year following the format of the contribution margin income statement as shown above with columns for each of the two types (assume 32% tax rate, and that any loss before taxes yields a 32% tax savings).

8.) If sales greatly increase, which type (food cart or truck) would experience a greater increase in profit? What if sales declined -which product would experience a greater loss or reduction in income? Explain why. How does your calculation from (4) support your point?

9.) Thinking about sales, is there any day of the week or time of day when greater sales are expected? Which type is more sensitive to this occurrence? Which type is less sensitive to this occurrence? Which type is more advantageous and why? Is there anything else the company can do to manage the decline in sales that come with certain days and times?

10.)How do you recommend the company use the $30,000 advertising budget available under this scenario in order to achieve a maximum effect on their target audience?

11.)Compute the Profit Margin and Return on Assets for each scenario assuming average total assets of $500,000. Industry averages are 20% and 10% respectively

Answer 1

1) Contribution margin if GT decides to remain a regular food cart.

	Food Cart
Sales	$2,17,875
variable costs	$46,687.5
Contribution margin inn dollars	$1,71,187.5
Number of units	31,125
CM per unit	$5.50

Contribution margin if GT decides to remain a food truck

	Food Cart	Food Truck	Total
Sales	$2,17,875	$3,65,000	$5,82,875
variable costs	$46,687.5	$1,03,437.5	$1,50,125
Contribution margin inn dollars	$1,71,187.5	$2,61,562.5	$4,32,750
Number of units	31,125	45,625	76,750
CM per unit	$5.50		$6

2) Contribution margin ratio = contribution margin dollars / sales

	Food Cart	Food Truck	Total
Sales	$2,17,875	$3,65,000	$5,82,875
Contribution margin inn dollars	$1,71,187.5	$2,61,562.5	$4,32,750.0
Contribution margin ratio	78.57%		74.24%

3) Break even point = fixed costs / contrubution margin per unit

Break even point under original scenario = 90000 / 5.5

= 16,364 plates

Break even point under both scenarios = 237500 / 5.64

= 42122 plates

4) Operating leverage = (Sales - variable costs) / profits

Operating levergae under original scenaio = 217875 - 46687.5 / 81187.5

= 2.11

Operating leverage under second scenario = 582875 - 150125 / 195250

= 2.22

Operating leverage measures the what percentage the total cost comprises of the fixed cost and variable cost and how well a company uses its fixed costs to geenrate profits.

A DOL of 2.22 means if sales increases by $1, the profits will increase by 2.22 times of the increase in sales.

It is important to the management to set the correct prices so that an incremental volume can result in cost savings and increase profits.