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. Explain whether Mary's changes should be adopted. Why or why not? Analyze the above information (three bullet points above) and use this information to support your suggestion.

Answer 1

Current break-even point:$40X = $24X + $270,000

(where X = pairs of shoes)

$16X = $270,000X = 16,875 pairs of shoes

New break-even point:$38X = $24X + ($270,000 + $24,000)

$14X = $294,000X = 21,000 pairs of shoes

Current margin of safety ratio = (20,000 × $40) – (16,875 × $40)(20,000 × $40)= 16% (rounded)

New margin of safety ratio= (24,000 × $38) – (21,000 × $38)(24,000 × $38)= 13% (rounded)

BARGAIN SHOE STORE

CVP Income Statement

Current New

Sales $800000 $912000

Variable Expenses 480000 576000

Contribution Margin 320000 336000

Fixed Expenses 270000 294000

Net Income/(Loss) $50000 $42000

No The suggestion should not be adopted as the Net income is decreasing.