CVP Analysis at Mollys Cupcakes [1] (B) Recall Mollys information Revenue $34,000 - Expense 37,100 Profit (loss) Management responded with the following information Costs have

CVP Analysis at Mollys Cupcakes[1] (B)

Recall Mollys information

Revenue $34,000

- Expense 37,100

Profit (loss) <$3,100>

Management responded with the following information

Costs have been matched to revenue to determine what costs should appear as expenses.

The costs of goods remaining in inventory are not included in expenses.

There are no fixed manufacturing costs.

Cost of sales is 40% of revenue.

$8,500 of the selling and administrative expenses are variable.

Costs and selling prices are expected to remain stable for at least the next two years.

Based on this information you created the following contribution margin format income statement and used it to analyze several alternatives for management.

% of

Revenue

Revenue 34,000

Variable COGS 13,600 40.00%

Variable S&A 8,500 25.00%

CM 11,900 35.00%

Fixed Cost 15,000 44.12%

Profit -3,100 -9.12%

Management is now wondering how sales mix will affect their financial picture. It provided the following information.

The current sales mix, computed as percent of total units, is 80% regular cupcakes and 20% deluxe cupcakes. The total number of cupcakes currently being sold is 10,000.

Regular cupcakes sell for $3.00 and have a contribution margin of $0.95 per unit.

Deluxe cupcakes sell for $5.00 and have a contribution margin of $2.15 per unit.

Management believes it can increase sales of deluxe cupcakes by rearranging the display case. Its best estimate is that deluxe cupcakes would increase to 48% of cupcakes sold.

It believes it will continue to have the same number of customers and sell the same number of cupcakes.

Part One:

Prepare a contribution format income statement with columns for each product line. Include a total company column as well. Do not give a break-out for fixed costs per product line. Instead, just put the total for fixed cost in the total company column.

Compute the current weighted average contribution margin per unit.

Compute the new weighted average contribution margin per unit that management expects will result from rearranging the display case.

Compute the amount of profit that Mollys would generate if rearranging the display case was successful (that is, if it achieved the predicted results). Explain how Mollys Cupcakes was able to be profitable even though it is still only selling 10,000 cupcakes in total.

Assume that Mollys is currently paying its sales staff a $0.25 per cupcake selling commission (variable selling expense). Does this encourage the staff to sell the high margin cupcakes? Explain.

Briefly describe a better way to pay commissions to your sales staff that aligns with overall company profitability.

Using the new weighted average contribution margin you computed in question 3, compute the number of cupcakes that Mollys must sell in order to generate a target profit of $3,000. How many of these cupcakes will be deluxe cupcakes?

Part Two:

Assume that Mollys implements the display case strategy that results in the revised sales mix and increased profitability. For long-run profitability, management is also considering purchasing a new machine that will mix, bake and frost the cupcakes, considerably reducing the amount of direct labor needed. If the machine is purchased, depreciation expense will increase by $10,000 for the period and direct labor costs will decrease by $.60 per cupcake for regular cupcakes and $.80 for deluxe cupcakes.

Prepare a new contribution formatted income statement assuming Mollys implements the display case strategy and sales volume grows to 15,000 cupcakes (Scenario 1). What is the new net operating income?

Prepare a new contribution formatted income statement assuming Mollys purchases the new machine and implements the new sales display strategy. Assume sales volume grows to 15,000 cupcakes (Scenario 2). What is the new net operating income?

Now we are going to look at operating risk. Calculate the BEP in sales dollars, Margin of Safety Percentage, Operating Leverage and Profit sensitivity for each scenario.

Evaluate the risk of Scenario One versus Scenario Two. Which scenario inherently has more risk?

Using the profit sensitivity multiplier, determine the change in profit under both scenarios if sales go up by 30%? Down by 30%?

Using your results from question 5, what conclusion can you make about the most favorable operating structure for Mollys? Hint: calculate the sales volume where profit is equal under both operating structures.