Question

Erin Shelton, Inc., wants to earn a target profit of $800,000 this year. The company’s fixed costs are expected to be $1,000,000 and its variable costs are expected to be 60 percent of sales. Erin Shelton, Inc., earned $700,000 in profit last year. Required: 1. Calculate break-even sales for Erin Shelton, Inc. 2. Prepare a contribution margin income statement on the basis break-even sales. (Do not leave any cells blank, enter a zero wherever required.) 3. Calculate the required sales to meet the target profit of $800,000. 4. Prepare a contribution margin income statement based on sales required to earn a target profit of $800,000. 5. When the company earns $800,000 of net income, what is its margin of safety and margin of safety as a percentage of sales? (Round your "Percentage Sales" answer to 2 decimal places. (i.e. .1234 should be entered as 12.34%.))

Answer 1

1) Contribution margin ratio = 100-60 = 40%

Break even sales = Fixed cost/Contribution margin ratio = 1000000/.40 = $2500000

2) Contribution margin income statement

Sales	2500000
Variable cost	1500000
Contribution margin	1000000
Fixed cost	1000000
Net operating income	0

3) Required sales = (Fixed cost+Desired profit)/Contribution margin ratio = (1000000+800000)/.40 = $4500000

4) Contribution margin income statement

Sales	4500000
Variable cost	2700000
Contribution margin	1800000
Fixed cost	1000000
Net operating income	800000

5) Margin of safety = 4500000-2500000 = 2000000

Margin of safety ratio = 2000000/4500000 = 44.44%