Question

Scenario: Mary Willis is the advertising manager for Bargain Shoe Store. She is currently working on a major promotional campaign. Her ideas include the installation of a new lighting system and increased display space that will add $24,000 in fixed costs to the $270,000 in fixed costs currently spent. In addition, Mary is proposing a 5% price decrease ($40 to $38) will produce a 20% increase in sales volume (20,000 to 24,000). Variable costs will remain at $24 per pair of shoes. Management is impressed with Mary's ideas but concerned about the effects these changes will have on the break-even point and the margin of safety.

Answer 1

Current break even point = (Fixed cost / Contribution margin per unit)
	=	(270,000 / (40-24) ) = 16,875 pair of shoes
New break even point = (Fixed cost / Contribution margin per unit)
	=	[(270,000+24,000) / (38-24)] = 21,000 pair of shoes
Current margin of safety ratio = (Sales - break even sales) /sales
	=	[(20,000*40) - (16,875*40) / (20,000*40)]
	=	(125,000 / 800,000)
	=	16%
New margin of safety ratio = (Sales - break even sales) /sales
	=	[(24,000*38) - (21,000*38) / (24,000*38)]
	=	(114,000 / 912,000)
	=	13%