ACCT 2102 Chapter Notes - Chapter 5: Operating Leverage
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Case 9-6: Profit PlanningâChoice of CostStructure
The owner of a package delivery business is currently evaluatingthe choice between two different cost structures, based on how thedelivery personnel are paid. One option (hereafter, âAlternative#1â) has relatively higher short-term fixed costs, while the otheroption (hereafter, âAlternative #2â) has the reverseâthat is,relatively higher variable costs in its cost structure. (Forsimplicity in this example we hold the delivery cost per package,that is, the selling price per unit is constant. Selling price isindependent of the cost-structure choice.) The following tablecontains pertinent information for creating the CVP model for eachdecision alternative:
Decision Inputs (Data) | Cost Structure Alternative #1 | Cost Structure Alternative #2 |
Delivery price (i.e., revenue) per package | $60 | $60 |
Variable cost per package delivered | $48 | $30 |
Contribution margin per unit | $12 | $30 |
Fixed costs (per year) | $600,000 | $3,000,000 |
Requirements
1. What is meant by the term âshort-term profit-planningâ model,and how can such a model be used by management? (That is, in whatsense can this model be used to facilitate planning, control, ordecision-making by managers of an organization?)
2. What are the definitions of fixed costs, variable costs,contribution margin ratio, contribution margin per unit, andrelevant range?
3. What is the break-even point, in terms of number ofdeliveries per year (or per month), for Alternative #1? ForAlternative #2?
4. How many deliveries would have to be made under Alternative#1 to generate a pre-tax profit, ÏB, of $25,000per year?
5. How many deliveries (per month or per year) would have to bemade under Alternative #1 to generate a pre-tax profit,ÏB, equal to 15% of sales revenue?
6. How many deliveries would have to be made under Alternative#2 to generate an after-tax profit, ÏA, of$100,0000 per year, assuming a tax rate of, say, 45%?
7. Assume that for the coming year total fixed costs areexpected to increase by 10% for each of the two alternatives. Whatis the new break-even point, in terms of number of deliveries, foreach decision alternative? By what percentage did the break-evenpoint change for each case? How do these figures compare to thepercentage increase in budgeted fixed costs?
8. Assume an average income-tax rate of 40%. What volume (numberof deliveries) would be needed to generate an after-taxprofit, ÏA, of 5% of sales for each alternative?
1.
Payton Industries has fixed costs of $490,000, the unit sellingprice is $35, and the unit variable costs are $20. What is thebreak-even sales (units) if fixed costs are reduced by $40,000?
| a. | 32,667 units | |
| b. | 14,000 units | |
| c. | 24,500 units | |
| d. | 30,000 units |
2.
Rusty Co. sells two products, X and Y. Last year, Rusty sold5,000 units of X and 35,000 units of Y. Related data are:
Unit Selling Price | Unit Variable | Unit Contribution | |
Product | Price | Cost | Margin |
X | $110.00 | $70.00 | $40.00 |
Y | 70.00 | 50.00 | 20.00 |
â
â
What was Rusty Co.âs weighted average unit contributionmargin?
| a. | $20.00 | |
| b. | $22.50 | |
| c. | $60.00 | |
| d. | $40.00 |
3.
Charlotte Co. has budgeted salary increases to factorysupervisors totaling 9%. If selling prices and all other costrelationships are held constant, next year's break-even point
| a. | cannot be determined from the data given | |
| b. | will increase by 9% | |
| c. | will decrease by 9% | |
| d. | will increase at a rate greater than 9% |
4.
Flying Cloud Co. has the following operating data for itsmanufacturing operations:
| Unit selling price | $250 |
| Unit variable cost | 100 |
| Total fixed costs | $840,000 |
â
The company has decided to increase the wages of hourly workerswhich will increase the unit variable cost by 10%. Increases in thesalaries of factory supervisors and property taxes for the factorywill increase fixed costs by 4%. If sales prices are held constant,the next break-even point for Flying Cloud Co. will be
| a. | increased by 800 units | |
| b. | increased by 640 units | |
| c. | increased by 400 units | |
| d. | decreased by 640 units |
5.
Given the following cost and activity observations for BountyCompanyâs utilities, use the high-low method to calculate Bountyâvariable utilities costs per machine hour. Round your answer to thenearest cent.
â
â | Cost | Machine Hours |
March | $3,100 | 15,000 |
April | 2,700 | 10,000 |
May | 2,900 | 12,000 |
June | 3,600 | 18,000 |
| a. | $10.00 | |
| b. | $0.11 | |
| c. | $0.63 | |
| d. | $0.67 |
6.
Costs that remain constant in total dollar amount as the levelof activity changes are called
| a. | variable costs | |
| b. | mixed costs | |
| c. | product costs | |
| d. | fixed costs |
7.
Lee Industry sales are $525,000, variable costs are 53% ofsales, and operating income is $19,000. What is the contributionmargin ratio?
| a. | 47% | |
| b. | 26.5% | |
| c. | 53% | |
| d. | 9.5% |
8.
If Kaden Company's fixed costs are $46,800, the unit sellingprice is $42, and the unit variable costs are $24. What is thebreak-even sales (units)?
| a. | 1,950 | |
| b. | 1,114 | |
| c. | 2,400 | |
| d. | 2,600 |
9.
Contribution margin is
| a. | the same as sales revenue | |
| b. | the excess of sales revenue over variable cost | |
| c. | another term for volume in the "cost-volume-profit" analysis | |
| d. | profit |
| #1 | Which of the following correctly describes fixed and variable cost behavior as total volume increases? | ||
| A. | Unit fixed costs stay the same and unit variable costs increase. | ||
| B. | Total fixed costs stay the same and total variable costs increase. | ||
| C. | Unit fixed costs decrease and total variable costs decrease. | ||
| D. | Unit fixed costs decrease and unit variable costs decrease. | ||
| #2 | The incremental profit generated by the sale of one additional unit is equal to the | ||
| A. | contribution margin per unit. | ||
| B. | selling price. | ||
| C. | margin of safety. | ||
| D. | incremental cost. | ||
| #3 | Clipper Office Furniture uses cost-plus pricing with a 40% mark-up on total cost at capacity. The company is currently selling 40,000 units at $19.60 per unit. Each unit has a variable cost of $9. In addition, the company incurs $200,000 in fixed costs annually. If demand falls to 32,000 units and the company wants to continue to earn a 40% return, what price should the company charge? | ||
| A. | $15.25 | ||
| B. | $21.35 | ||
| C. | $19.60 | ||
| D. | $27.44 | ||
| #4 | ABC company has $6.50 per unit in variable costs and $2.20 per unit in fixed costs at a volume of 40,000 units. If the company uses cost-plus 20% for pricing, which of the following should the company use to determine the price? | ||
| A. | The company should use a unit cost of $8.70 per unit only at a volume of 40,000 units. | ||
| B. | The company should use a unit cost of $8.70 at any volume level. | ||
| C. | The company should use a unit price of $10.44 at any volume level. | ||
| D. | The company should ignore fixed costs for cost-plus pricing. | ||
| #5 | Which of the following is a grouping of overhead costs whose total is allocated using one allocation base? | ||
| A. | Cost objective | ||
| B. | Cost pool | ||
| C. | Direct cost | ||
| D. | Cost driver | ||
| #6 | Which one of the following is the preferred alternative when deciding between two options? | ||
| A. | Incremental profit is greater than under the other alternatives. | ||
| B. | Revenues are greater than under the other alternatives. | ||
| C. | Expenses are less than under the other alternatives. | ||
| D. | No opportunity or sunk costs exist. | ||
| #7 | The required rate of return used to calculate an investmentâs net present value is related to the firmâs | |||
| A. | contribution margin. | |||
| B. | cost of capital. | |||
| C. | total assets. | |||
| D. | Price/Earnings ratio. | |||
| #8 | A company is trying to decide whether to keep or drop the organic foods department in its grocery store. If organic foods are dropped, the manager will be laid off. What is the manager's salary in relation to the decision to keep or drop the department? | |||
| A. | A variable cost and therefore relevant | |||
| B. | Avoidable and therefore incremental | |||
| C. | Sunk and therefore not relevant | |||
| D. | A fixed cost and therefore not relevant | |||
| #9 | The following information relates to Ajax Widgets during the year. There was no beginning inventory. | |||
| Units produced | 11,000 | |||
| Units sold | 10,000 | |||
| Units in ending inventory | 1,000 | |||
| Fixed manufacturing overhead | $220,000 | |||
| How much fixed manufacturing overhead will be expensed during the year (included in Cost of Goods Sold) using full costing? | ||||
| A. | $220,000 | |||
| B. | $200,000 | |||
| C. | $20,000 | |||
| D. | $10,000 | |||
| #10 | If the required rate of return is greater than the internal rate of return of a potential investment, the company should judge the investment as acceptable. | |||
| A. | This is a True statement | |||
| B. | This is a False statement | |||
| C. | Not enough information provided. | |||
| #11 | The basic concept involved in time value of money calculations is that | |||
| A. | it is better to receive a dollar in the future than to receive a dollar today | |||
| B. | incremental revenues must exceed incremental costs. | |||
| C. | it is better to receive a dollar today than to receive a dollar in the future. | |||
| D. | it can only be applied to positive cash flows | |||
| #12 | Hanson Sports has three product lines: footballs, basketballs, and bats. Common costs are allocated based on relative sales. A product line income statement for the year ended December 31, 2016 follows: | ||||
| Footballs | Basketballs | Bats | Total | ||
| Sales | $600,000 | $800,000 | $400,000 | $1,800,000 | |
| Cost of goods sold | 260,000 | 400,000 | 230,000 | 890,000 | |
| Gross margin | 340,000 | 400,000 | 170,000 | 910,000 | |
| Less other variable costs | 85,000 | 120,000 | 80,000 | 285,000 | |
| Contribution margin | 255,000 | 280,000 | 90,000 | 625,000 | |
| Less direct salaries | 50,000 | 60,000 | 45,000 | 155,000 | |
| Less common fixed costs | 85,000 | 100,000 | 55,000 | 240,000 | |
| Net income | $120,000 | $120,000 | -$10,000 | $230,000 | |
| Since the profit for bats is a net loss, the company is considering dropping this product line. What is the incremental $ effect on total net income of dropping the Bats line? | |||||
| #13 | Right Air Supply sells a specialized air filter that has a variable cost of $10 each. | ||||
| Fixed costs are estimated to be $700,000 across all levels of sales shown below. | |||||
| Units Sold | Unit Price | CM per unit x Qty | Fixed Costs | Profit | |
| 90,000 | $33 | 700,000 | |||
| 100,000 | $31 | 700,000 | |||
| 110,000 | $30 | 700,000 | |||
| 120,000 | $28 | 700,000 | |||
| Which price should Right Air Supply charge to maximize profits? | |||||
| #14 | Randolph Corporation sells a single product at a price of $275 per unit. Variable cost per unit is $135 and fixed costs total $356,860. If sales are expected to be $825,000, what is the companyâs margin of safety? | ||||
| #15 | Roger Excavating Company experienced the following costs in 2016: | ||||
| Direct materials | $1.75 per unit | ||||
| Direct labor | $2.00 per unit | ||||
| Variable manufacturing overhead | $2.50 per unit | ||||
| Variable selling | $0.75 per unit | ||||
| Fixed manufacturing overhead | $50,000 | ||||
| Fixed selling | $15,000 | ||||
| Fixed administrative | $5,000 | ||||
| During 2016, the company manufactured 100,000 units and sold 80,000 units. If the average selling price per unit was $22.65, what is the amount of the companyâs contribution margin per unit? | |||||
