FINANCE

18.

CVP and Break-Even Analysis LO1, 2, 3

Lauren Tarson and Michele Progransky opened Top Drawer Optical seven years ago with the goal of producing fashionable and affordable eyewear. Tarson and Progransky have been very pleased with their revenue growth. One particular design, available in plastic and metal, has become one of the company’s best sellers. The following data relate to this design:

  Plastic Frames Metal Frames
Sales price $ 60.00 $ 80.00
Direct materials   20.00   18.00
Direct labor   13.50   13.50
Variable overhead    6.50    8.50
Budgeted unit sales  10,000  30,000

Currently, the company produces exactly as many frames as it can sell. Therefore, it has no opportunity to substitute a more expensive frame for a less expensive one. Top Drawer Optical’s annual fixed costs are $1.225 million.

Required

Each of the following is an independent situation.

· A. Calculate the total number of frames that Top Drawer Optical needs to produce and sell to break even.

· B. Calculate the total number of frames that Top Drawer Optical needs to produce and sell to break even if budgeted direct material costs for plastic frames decrease by $10 and annual fixed costs increase by $12,500 for depreciation of a new production machine.

· C. Tarson and Progransky have been able to reduce the company’s fixed costs by eliminating certain unnecessary expenditures and downsizing supervisory personnel. Now, the company’s fixed costs are $1,122,000. Calculate the number of frames that Top Drawer Optical needs to produce and sell to break even if the company sales mix changes to 35 percent plastic frames and 65 percent metal frames.

Break-Even and Target Profit LO1, 2, 3, 4

Matthew Hagen started his company, The Sign of Things to Come, three years ago after graduating from Upper State University. While earning his engineering degree, Matthew became intrigued by all of the neon signs he saw at bars and taverns around the university. Few of his friends were surprised to see him start a neon sign company after leaving school. Matthew is currently considering the introduction of a new custom neon sign that he believes will sell like hot cakes. In fact, he is estimating that the company will sell 700 of the signs. The new signs are expected to sell for $75 and require variable costs of $25. The new signs will require a $30,000 investment in new equipment.

Required

· A. How many new signs must be sold to break even?

· B. How many new signs must be sold to earn a profit of $15,000?

· C. If 700 new signs are sold, how much profit will they generate?

· D. What would be the break-even point if the sales price decreased by 20 percent? Round your answer to the next-highest number.

· E. What would be the break-even point if variable costs per sign decreased by 40 percent?

· F. What would be the break-even point if the additional fixed costs were $50,000 rather than $30,000?

Decision Focus: Break-Even and Target Profit LO1, 2, 3, 4

ZIA Motors is a small automobile manufacturer. Chris Rickard, the company’s president, is currently evaluating the company’s performance and is considering options that might be effective at increasing ZIA’s profitability. The company’s controller, Holly Smith, has prepared the following cost and expense estimates for next year, on the basis of a sales forecast of $3,000,000:

Direct materials  $  800,000
Direct labor    700,000
Factory overhead    750,000
Selling expenses    300,000
Other administrative expenses    100,000
  $2,650,000

After Chris received and reviewed the cost and expense estimates, he realized that Holly had given him all the data without breaking it out into fixed and variable components. He called her, and she told him the following: “Factory overhead and selling expenses are 40 percent variable, but other administrative expenses are 30 percent variable.”

Required

· A. How much revenue must ZIA generate to break even?

· B. Chris Rickard has set a target profit of $700,000 for next year. How much revenue must ZIA generate to achieve Chris’s goal?

Break-Even and Target Profit Analysis LO1, 2, 3, 4

Boeing Corporation (formerly McDonnell Douglas Corporation) manufactures the C-17, the most flexible jet transport used by the U.S. Air Force. The company originally sold the C-17 for a “flyaway cost” of $175 million per jet. The variable production cost of each C-17 was estimated to be approximately $165 million. When the C-17 was first proposed in 1981, the Air Force expected to eventually purchase 400 jets. However, as of June 2011, only 232 C-17s have been produced and sold.

Production began, and at one point the company was faced with the following situation: With 20 jets finished, a block of 20 more in production, and funding approved for the purchase of a third block of 20 jets, the U.S. Congress began indicating that it would approve funding for the order and purchase of only 20 more jets (for a total of 80). This was a problem for the company because company officials had indicated previously that the break-even point for the C-17 project was around 100 aircraft.

Required

· A. Given the previous facts concerning the sales price, variable cost, and break-even point, what were McDonnell Douglas’s fixed costs associated with the development of the C-17?

· B. What would the income or loss be if the company sold only 80 C-17s?

· C. Assume that McDonnell Douglas had been told up front that the Air Force would buy only 80 jets. Calculate the selling price per jet that the company would have to charge to achieve a target profit (before tax) of $10 million per jet.

· D. Assuming that the costs and sales price of the jet have remained the same over the years, how much income have McDonnell Douglas and Boeing made from the sale of the C-17?

1

Calculating the optimum mix of products to produce given limited resources and demand constraints is addressed in Chapter 7 . The optimum mix will result in the highest overall contribution margin and also the highest overall profit for a company

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