Break-Even in Units, Target Income, New Unit Variable Cost, Degree of Operating Leverage, Percent Change in Operating Income

Reagan, Inc., has developed a chew-proof dog bedthe Tuff-Pup. Fixed costs are $224,000 per year. The average price for the Tuff-Pup is $37, and the average variable cost is $23 per unit. Currently, Reagan produces and sells 20,000 Tuff-Pups annually.

Required:

1. How many Tuff-Pups must be sold to break even? units

2. If Reagan wants to earn $78,400 in profit, how many Tuff-Pups must be sold? units

Feedback

1. See Cornerstone 16.2.

2. Combine desired profit with fixed costs in the formula.

Prepare a variable-costing income statement to verify your answer.

Reagan, Inc.
Variable-Costing Income Statement
Sales	$
Less: Variable cost
Contribution margin	$
Less: Fixed expenses
Operating income	$

Break-Even in Units, After-Tax Target Income, CVP Assumptions

Campbell Company manufactures and sells adjustable canopies that attach to motor homes and trailers. The market covers both new unit purchases as well as replacement canopies. Campbell developed its business plan for the year based on the assumption that canopies would sell at a price of $400 each. The variable costs for each canopy were projected at $200, and the annual fixed costs were budgeted at $120,000. Campbells after-tax profit objective was $231,000; the companys effective tax rate is 40 percent.

While Campbells sales usually rise during the second quarter, the May financial statements reported that sales were not meeting expectations. For the first five months of the year, only 350 units had been sold at the established price, with variable costs as planned, and it was clear that the after-tax profit projection for the year would not be reached unless some actions were taken. Campbells president assigned a management committee to analyze the situation and develop several alternative courses of action. The following mutually exclusive alternatives, labeled A, B, and C, were presented to the president:

A. Lower the variable costs per unit by $25 through the use of less expensive materials and slightly modified manufacturing techniques. The sales price will also be reduced by $30, and sales of 2,200 units for the remainder of the year are forecast.

B. Reduce the sales price by $40. The sales organization forecasts that with the significantly reduced sales price, 2,700 units can be sold during the remainder of the year. Total fixed and variable unit costs will stay as budgeted.

C. Cut fixed costs by $10,000, and lower the sales price by 5 percent. Variable costs per unit will be unchanged. Sales of 2,000 units are expected for the remainder of the year.

Be sure to support your selection with appropriate calculations.

	After-tax profit
Alternative A	$
Alternative B	$
Alternative C	$

Operating Leverage

Income statements for two different companies in the same industry are as follows:

		Trimax, Inc.		Quintex, Inc.
Sales		$300,000		$337,500
Less: Variable costs		150,000		67,500
Contribution margin		$150,000		$270,000
Less: Fixed costs		120,000		240,000
Operating income		$30,000		$30,000

Required:

3. Suppose that both companies experience a 40 percent increase in revenues. Compute the percentage change in profits for each company.

Trimax		%
Quintex		%