I NEED ALL QUESTIONS ANSWERED. THANK YOU. The owner of a package delivery busine

ID: 2470151 • Letter: I

Question

I NEED ALL QUESTIONS ANSWERED. THANK YOU.

The owner of a package delivery business is currently evaluating the choice between two different cost structures, based on how the delivery personnel are paid. One option (hereafter, “Alternative #1”) has relatively higher short-term fixed costs, while the other option (hereafter, “Alternative #2”) has the reverse—that is, relatively higher variable costs in its cost structure. (For simplicity in this example we hold the delivery cost per package, that is, the selling price per unit is constant. Selling price is independent of the cost-structure choice.) The following table contains pertinent information for creating the CVP model for each decision alternative: Decisions Inputs(data) Cost Structure Cost Structure Alternative #1 Alternative #2 Delivery Price (i.e.revenue) $60 $60 per package Variable cost per package delivered $48 $30 Contribution margin per unit $12 $30 Fixed costs (per year) $600,000 $3,000,000 Cost Structure Alternative #1 Decisions Inputs(data) Delivery Price (i.e.revenue) per package $60 Variable cost per package delivered $48 Contribution margin per unit $12 Fixed costs (per year) $600,000 Cost Structure Alternative #2 Decisions Inputs(data) Delivery Price (i.e.revenue) per package $60 Variable cost per package delivered $30 Contribution margin per unit $30 Fixed costs (per year) $3,000,000

(3) What is the break-even point, in terms of number of deliveries per year (or per month), for Alternative #1? For Alternative #2?

(4) How many deliveries would have to be made under Alternative #1 to generate a pre-tax profit, B, of $25,000 per year?

(5) How many deliveries (per month or per year) would have to be made under Alternative #1 to generate a pre-tax profit, B, equal to 15% of sales revenue?

(6) How many deliveries would have to be made under Alternative #2 to generate an after-tax profit, A, of $100,0000 per year, assuming a tax rate of, say, 45%?

(7) Assume that for the coming year total fixed costs are expected to increase by 10% for each of the two alternatives. What is the new break-even point, in terms of number of deliveries, for each decision alternative? By what percentage did the break-even point change for each case? How do these figures compare to the percentage increase in budgeted fixed costs?

(8) Assume an average income-tax rate of 40%. What volume (number of deliveries) would be needed to generate an after-tax profit, A, of 5% of sales for each alternative?

(9) Consider the original data in the problem. Construct a graph for each of the two alternatives depicting pre-tax profit, B, as function of volume (number of deliveries per year). Clearly label the profit equation for each alternative.

10) Based on the graphs prepared in(9), which decision alternative do you think is the more profitable one for this business?

(11) Based on the original data and the graphs prepared above in

(10), which decision alternative is more risky to the business? Explain. (Hint: Think about, and define in your answer, the notion of “operating leverage.”)

(12) Finally, in building your profit-planning (i.e., CVP) model, the analyst makes a number of important assumptions. List the primary assumptions that underlie a conventional CVP analysis, such as the ones you conducted above.

Explanation / Answer

Solution:

Particulars

Alternative 1

Alternative 2

Delivery Price (i.e. revenue) per package

$60

Variable cost per package delivered

$48

$30

Contribution margin per unit

$12

$30

Fixed costs (per year)

$600,000

$3,000,000

(3) Break-even point, in terms of number of deliveries per year (or per month), for Alternative #1 & Alternative #2

Break Even Point in units = Fixed Cost / Contribution Margin Per Unit

Alternative 1:

Break Even Point in units = $600,000 / $12 = 50,000 deliveries per year or 4,167 deliveries per month

Alternative 2:

Break Even Point in units = $3,000,000 / $30 = 100,000 deliveries per year or 8,333 deliveries per month

(4) How many deliveries would have to be made under Alternative #1 to generate a pre-tax profit, of $25,000 per year?

Number of deliveries to be made to generate a pretax profit of $25,000 per year (Alternative 1) = (Fixed Cost + Desired Profit) / Contribution Margin Per Unit

= ($600,000 + $25,000) / $12 = 52,083.33 or 52,083 deliveries per year

(5) How many deliveries (per month or per year) would have to be made under Alternative #1 to generate a pre-tax profit, equal to 15% of sales revenue?

Break Even Units (as calculated above) = 50,000 Units

Break Even sales = 50,000 x 60 = $3,000,000

Desired Profit = 15% of Sales Revenue = 15% x $3,000,000 = $450,000

Number of deliveries to be made to generate a pretax profit of 15% of sales revenue (Alternative 1) = (Fixed Cost + desired Profit) / Contribution margin per unit = ($600,000 + $450,000) / $12 = 87,500 deliveries per year

(6) How many deliveries would have to be made under Alternative #2 to generate an after-tax profit of $100,0000 per year, assuming a tax rate of, say, 45%?

Number of deliveries would have to be made under Alternative 2 to generate an after tax profit of $1000,000 per year = (Fixed Cost + Desired Profit before Tax) / Contribution Margin Per Unit

Desired Profit Before tax = Desired Profit after tax / (1 – Tax Rate) = $1000,000 / (1 – 0.45) = $1,818,181.81

Number of deliveries would have to be made under Alternative 2 to generate an after tax profit of $1000,000 per year = ($,3000,000 + $1,818,181.81) / 30 = 160,606 deliveries

For rest parts – please ask separate question