Cost-Volume-Profit Analysis
A freshman in high school is trying to earn enough money to pay for college and has decided to start a small business. Her company, Pretty Paws, will produce custom made dog collars. The student has calculated variable costs per unit to produce the collars at $8 per unit. The only fixed costs incurred will be from rental space needed to assemble the collars and to store supplies and product. She has found a space for $500 per month. This space is large enough to accommodate 8 employees. If she hires more than 8 people she will need to increase the space which will cost an additional $500 per month. She has determined that each employee will be able to produce 2,000 collars per year. Using the internet, she will be able to sell as many units as she can produce. She plans to set the selling price at $10 per unit.
(1) Prepare a contribution margin Income statement that reflects how much net income can be earned with one, two, and three employees (this is one statement with three columns one column for each employee level).
(2) What is the break-even amount in units for Pretty Paws if less than 9 employees are hired.
(3) If the owner wishes to earn a target profit of $50,000 per year, how many units will she need to sell?
(4) Using a contribution margin income statement to demonstrate:
(a) What is the maximum amount of net income that Pretty Paws can earn if 8 employees are hired and each works to their full production capability?
(b) All other items being constant, what price needs to be charged for Pretty Paws to earn a target profit of $50,000 with only 8 employees (assume each employee works to their full production capability)?
(5) As an MBA student, you have both experience and education that the owner of Pretty Paws does not. Do you think she should maintain her original price of $10 or increase her price to the amount you calculated in part 4(b)? Include your reasoning for this recommendation.