Alma Ortiz is the advertising manager for CostLess Shoe Store. She is currently

Question

Alma Ortiz is the advertising manager for CostLess 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 $18,000 in fi xed costs to the $216,000 currently spent. In addition, Alma is proposing that a 10% price decrease (from $30 to $27) will produce an increase in sales volume from 20,000 to 24,000 units. Variable costs will remain at $12 per pair of shoes. Management is impressed with Alma’s ideas but concerned about the effects that these changes will have on the break-even point and the margin of safety. Instructions

(a) Compute the current break-even point in units, and compare it to the break-even point in units if Alma’s ideas are used.

(b) Compute the margin of safety ratio for current operations and after Alma’s changes are introduced. (Round to nearest full percent.)

(c) Prepare a CVP income statement for current operations and after Alma’s changes are introduced. (Show column for total amounts only.) Would you make the changes suggested?

Explanation / Answer

a)

Breakeven point = Fixed Costs / Contribution per unit

As we can see, the breakeven point has increased from current 12,000 units to 15,600 units.

b)

Margin of Safety = Current Sales Level – Breakeven Point
                                        Current Sales Level

Margin of Safety Current = (20,000 - 12,000) / 20,000 = 40%

Margin of safety Proposed = (24,000 - 15,600) / 24,000 = 35%

c)

Total Contribution = Contribution per unit x Sales volume

As we can find, due to the proposed changes, the profit has fallan from $144,000 to $126,000. So, the proposal should not be accepted.

Volume 20000 24000 Particulars Current Proposed Sale 30 27 Less: Variable costs 12 12 Contribution per unit 18 15 Fixed Costs 216000 234000 Breakeven point (units) 12000 15600

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