Question

9-37 CVP Analysis; Strategy Bubba's Western Wear is a western hat retailer in Lubbock, Texas. Although Bubba's carries numerous styles of western hats, each hat has approximately the same price and purchase cost, as shown in the following table. Sales personnel receive a commission to encourage them to be more aggressive in their sales efforts. Currently, the Lubbock economy is really hum- ming, and sales growth at Bubba's has been great. The business is very competitive, however, and Bubba, the owner, has relied on his knowledgeable and courteous staff to attract and retain customers who otherwise might go to other western wear stores. Because of the rapid growth in sales, Bubba is also finding the management of certain aspects of the business more difficult, such as restocking inventory and hiring and training new salespeople $ 80.00 Sales price Per unit variable expenses Purchase cost Sales commissions Total per unit variable costs Total annual fixed expenses Advertising Rent Salaries Total fixed expenses 43.50 11.50 $ 55.00 $ 98,500 146,500 255,000 $500,000 Required 1. Calculate the annual breakeven point, both in terms of units and in terms of sales dollars 2. If Bubba's sells 22,000 hats, what is its before-tax income or loss? Support your answer by constructing a contribution income statement 3. If Bubba's sells 32,000 hats, what is its margin of safety (MOS) and MOS ratio? Of what interpretive value are these two measures? 4. Bubba is considering the elimination of sales commissions completely and increasing salaries by $157,000 annually. What would be the new breakeven point in units? What would be the before-tax income or loss if 22,000 hats are sold with the new salary plan? 5. Identify and discuss the strategic and ethical issues in the decision to eliminate sales commissions (see requirement 4). How do these strategic concerns affect Bubba's decision? Should he stick with commission or eliminate them? Please explain #5.

Answer 1

Total Fixed Costs:

Advertising 98500 Rent 146500 Salaries 255000 Total 500000

Contribution Per Unit:

Selling Price	80
Less: Purchase Cost	43.5
Sales commission	11.5
Contribution per unit	25

1.

So B.E.P (Units) => Fixed cost/ contribution per unit => 500000/25 = 20000 units

BEP (Sales) = 20000*80 = $ 1,600,000.

2. 22000 units

Sales: (22000*80)	1760000
Less: Variable costs (55*22000)	1210000
Contribution	550000
Less: Fixed Costs	500000
Profit before Taxes	50000

3. 32000 Units:

Sales (32000*80)	2560,000
Less: BEP Sales	1600,000
M.O.S.	960000
MOS Ratio	960000/1600000*100 = 60%

4. eliminate sales commission:

Contribution => 80 - 43.50 = 36.50

Fixed Costs

Existing	500000
Sales Salaries	157000
Total	657000

So, BEP (units) => 657000/36.50 = 18000 units.

If 22000 units are sold:

Contribution (22000*36.50)	803000
Less: Fixed Costs	657000
Profit	146000

5. Eliminating Sales commission will decrease the attitude and determination in the sales force as they would be anyway getting fixed salaries regardless of the sales. Thus there may be fall in force. However financially introducing the fixed salary method will increase the profits and reduce the Break Even Point. Hence Financially its advantageous, but sales wise it may affect adversely in the long run.

6. Since BEP Sales are reduced by 4000 units plus by contrasting profits before taxes generated at 22000 units level, the company should eliminate sales commission and introduce the fixed salary method.