Mollys Cupcakes management is trying to decide whether to stay in business. They are currently losing money and want to know how close they are to making a profit and whether they should invest in advertising.

Mollys provided the following information

Revenue $34,000

- Expense 37,100

Profit (loss) <$3,100>

When talking to Mollys management, you first asked two questions to help you understand the data provided:

What costs are included in expenses?

How do these costs behave?

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.

1.Show that you understand Mollys cost structure by writing its income statement in contribution margin format.

2.Management wants to know how close they are to making a profit. Compute the increase in revenue required for Mollys to break even.

3.Management has the opportunity to invest in monthly advertising. This advertising is expected to increase sales volume by 20%. What is the most it should be willing to pay for this advertising?

4.Suppose the monthly advertising costs $600. By what percentage would the advertising need to increase sales volume in order for the firm to break even? Do you think this is achievable? Explain.

5.Rather than engaging in advertising, Mollys will try to cut costs. By what amount would management need to cut fixed costs in order to breakeven?

6.Management believes it can cut fixed cost by $1,500. It has also learned through trade association meetings that similar stores have selling and administrative expenses of 12% of revenue. If management is able to achieve these two cost savings, will it at least break even?

7.Which would you recommend to Molly's: increase volume through advertising, or cost control? Explain.

8.Ignore the advertising and cost cutting. Compute the amount of revenue that Mollys would need in order to show a $1,500 profit.If Mollys was operating at this target profit level, what would be its margin of safety?

9.Do the questions you just answered sound like real business questions you might face some day?