Wendy Barnes is the advertising manager for Value Shoe Store. She is currently w

Question

Wendy Barnes is the advertising manager for Value 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 $34,000 in fixed costs to the $270,000 currently spent. In addition, Wendy is proposing that a 5% price decrease ($40 to $38.00) will produce a 20% increase in sales volume (20,000 to 24,000). Variable costs will remain at $22 per pair of shoes. Management is impressed with Wendy's ideas but concerned about the effects that these changes will have on the break-even point and the margin of safety.

a) Compute the current break-even point in units, and compare it to the break-even point in units if wendy's ideas are used

b) compute the margin of safety ratio for current ratio for current operations and after wendy's changes are introduced. (Round to nearest full percent)

c) prepare a CVP income statement for current operations and after wendy's changes are introduced. Would you make these changes?

Explanation / Answer

Total fixed cost = 34000+270000

                         = 304000

Current price = 38

Sales = 24000

Variable cost = $22

New breakeven point = Fixed cost / contribution per unit

Contribution per unit = sales per unit -variable cost per unit

= 38- 22

=$16

Breakeven point = $304000 / 16

                          =19000 units of volume should be sale

b)

New margin of safety (in dollars) = Actual sales - Break even sales

                                                     =(24000*38) - (19000*38)

                                                     =912000-722000

                                                     =$190,000

c)

Old breakeven :

old selling price = 40

old variable cost = 22

fixed cost = $270000

BEP   = 270000 /(40-22)

          = $270000 / 18

           = 15000 units..

Old margin of safety in dollars = (20000 *40) - (15000*40)

                                                   =800000-600000

                                                    =$200,000

so the idea have changed the Breakeven point from 15000 units to 19000 units and Margin of softy from $200,000 to $190,000

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