MBA 620 Week 3 Homework

1. Ace Company sells lawn mowers for $200 per unit. Variable cost per unit is $40, and fixed costs total
$4,000. Last month, Ace sold 760 lawn mowers.
a. Calculate the contribution margin for last month. (5.3)
CM = total Rev – VC = 200*760 – 40*760 = $121,600
b. Calculate the contribution margin per unit. (6.1)
Unit CM = s – v = 200 – 40 = $160 per unit
c. Calculate the contribution margin ratio. (6.1)
CM ratio = (s – v) / s = $160 / $200 = 0.80 or 80%

2. Nellie Company has monthly fixed costs totaling $100,000 and variable costs of $20 per unit. Each
unit of product is sold for $25. (6.1)
a. Calculate the contribution margin per unit.
Unit CM = s – v = 25 – 20 = $5/unit
b. Calculate the contribution margin ratio.
CM ratio = (s – v)/s = 5/25 = 0.20 or 20%
c. Find the break-even point in units.
BE units = f / (s – v) = 100000 / 5 = 20,000 units
d. Find the break-even point in sales dollars.
BE $ = f / CM ratio = 100000 / 0.20 = $500,000
e. How many units must be sold to earn a monthly profit of $40,000?
Target units = (f + target) / (s – v) = (100000+40000) / 5 = 28,000
f. What amount of sales dollars is required to earn a monthly profit of $60,000?
Target $ = (f + target) / (CM ratio) = 160000/.20 = $800,000

3. Snowboard Company is a manufacturer of one model of snowboard. Their current revenues and
costs are based on the following information (the base case, copied from Figure 6.6 in the text).
Assume the unit sales price decreases by 10 percent from the base case. (6.3)

Base Case
Sales price per unit $250
Variable cost per unit $150
Monthly fixed costs $50,000
Volume of sales 700 units

a. Calculate the new projected profit.

Profit = revenues – vc – fc = 700*(.9*250 – 150) – 50,000 = $2,500
b. Calculate the dollar change in profit from the base case.
Base case profit = 700*(250 – 150) = $70,000 – 50,000 = $20,000
Change in profit = 20k – 2.5k = $17,500 decrease in profit
c. Calculate the percent change in profit from the base case.
% change in profit = change in profit / base case profit = 17500/20k = 87.5% decrease

4. High operating leverage means (choose one): (6.4)

 (a) The company has relatively low fixed costs. false
(b) The company has relatively high fixed costs. true
(c) The company will have to sell more units than a comparable company with low operating
leverage to break even. true
(d) The company will have to sell fewer units than a comparable company with low operating
leverage to break even. false
(e) Both (b) and (c) are correct.
(f) Both (a) and (d) are correct.

The answer is e, both b and c are correct.

5. CyclePath Company produces two different products that have the following price and cost
characteristics.

Bicycle Tricycle
Selling price per unit $200 $100
Variable cost per unit $120 $ 50

Management believes that pushing sales of the Bicycle product would maximize company profits
because of the high contribution margin per unit for this product. However, only 50,000 labor hours
are available each year, and the Bicycle product requires 4 labor hours per unit while the Tricycle
model requires 2 labor hours per unit. The company sells everything it produces. (6.5)

a. Calculate the contribution margin per unit of constrained resource for each model.

Bicycle Tricycle
Selling price per unit $200 $100
Variable cost per unit $120 $ 50
Unit CM $80 $50
LH required 4 2
Unit CM per LH $20/LH $25/LH

b. Which model would CyclePath prefer to sell to maximize overall company profit? Explain.

Until they can remove that constraint on labor hours (e.g., hire more workers), CyclePath would
be best served by selling the Tricycle.

6. When the units produced are greater than the units sold, which costing approach will yield the
highest profit? (choose one) (6.7)
a) Variable costing will have the higher profit.
b) Absorption costing will have the higher profit.
c) Profit will be the same under both variable and absorption costing.
d) None of the above.
(b). When units produced are greater than the units sold, absorption costing will record some
fixed OH costs as inventory, so COGS will be lower and profit higher under absorption costing.
7. Madden Company would like to estimate costs associated with its production of football helmets on
a monthly basis. The accounting records indicate the following production costs were incurred last
month for 4,000 helmets.

Assembly workers’ labor (hourly) $70,000

Factory rent 3,000
Plant manager’s salary 5,000
Supplies 20,000
Factory insurance 12,000
Materials required for production 20,000
Maintenance of production equipment (based on usage) 18,000

a. Identify which of the costs in the table above are fixed, and which are variable. (5.1)
See the table in (b) below
b. Use account analysis to estimate total fixed costs per month and the variable cost per unit. State
your results in the cost equation form Y = f + vX by filling in the dollar amounts for f and v. (5.2)

Fixed Variable
Assembly workers’ labor (hourly) $70,000
Factory rent 3,000
Plant manager’s salary 5,000
Supplies (best guess is that this is variable) 20,000
Factory insurance 12,000
Materials required for production 20,000
Maintenance of production equipment (based on usage) 18,000
Total costs 20,000 128,000
Total fixed costs = 20,000
Total variable costs = 128,000
Unit VC = $128,000 / 4,000 units = $32/unit

Y = $20,000 + $32X
c. Estimate total production costs assuming 5,000 helmets will be produced and sold. (5.2)
Y = 20,000 + 32*5,000 = $180,000
d. Prepare a contribution margin income statement assuming 5,000 helmets will be produced, and
each helmet will be sold for $70. Fixed selling and administrative costs total $10,000. Variable
selling and administrative costs are $8 per unit. (5.3)
Madden Company
Contribution Margin Income Statement (monthly projected)

Sales (5k * 70) $350,000

Variable COGS (5k * 32) 160,000
Variable Selling and Admin (5k * 8) 40,000
Contribution Margin $150,000
Fixed COGS 20,000
Fixed Selling and Admin 10,000
Net Operating Profit $120,000
8. Riviera Incorporated produces flat panel televisions. The company has annual fixed costs totaling
$10,000,000 and variable costs of $600 per unit. Each unit of product is sold for $1,000. Riviera
expects to sell 70,000 units this year. This is the base case. Assume a tax rate of 20%.
a. Find the break-even point in units.
BE units = f / (s – v) = 10,000,000 / (1000 – 600) = 25,000 units
b. How many units must be sold to earn an annual profit of $2,000,000?
Target units = (f + target) / (s – v) = (10M+2M) / (1000 – 600) = 30,000 units
c. Find the margin of safety in units.
Margin of safety = base case units – BE units = 70,000 – 25,000 = 45,000 units
d. What amount of sales dollars is required to earn an annual profit of $500,000 after taxes?
Step 1: find the pre-tax target profit
Pretax profit = After tax profit / (1-tax rate) = 500k / (1 - .2) = $625,000
Step 2: use the appropriate formula
Target $ = (f + pretax target) / CM Ratio
We need the CM Ratio = (s – v)/s = (1000 – 600)/1000 = .4
Target $ = (10,000,000 + 625,000) / 0.4 = $26,562,500
e. Find the contribution margin per unit for Riviera Inc.
Unit CM = s – v = 1000 – 600 = 400
f. How much will operating profit change if sales increase by 1,000 units?
If sales increase by 1000 units, profit will increase by the contribution margin on those
units:
Unit CM * 1000 units = 400 * 1000 = $400,000
g. Go back to the base case. How much will operating profit change if fixed costs are 15
percent higher than anticipated? Would this increase in fixed costs result in higher or lower
operating leverage?
See table below for calculation. Operating leverage would increase, since fixed costs
increase.
h. Go back to the base case. What will operating profit (loss) be if the variable cost per unit
increases 10%?

(f): units increase (g) :FC increase (h): VC per unit

Base Case by 1,000 15% increases 10%
Unit sales price $ 1,000 $ 1,000 $ 1,000 $ 1,000
Unit VC $ 600 $ 600 $ 600 $ 660
Total FC $ 10,000,000 $ 10,000,000 $ 11,500,000 $ 10,000,000
# units 70,000 71,000 70,000 70,000

Revenues $ 70,000,000 $ 71,000,000 $ 70,000,000 $ 70,000,000

VC $ 42,000,000 $ 42,600,000 $ 42,000,000 $ 46,200,000
CM $ 28,000,000 $ 28,400,000 $ 28,000,000 $ 23,800,000
FC $ 10,000,000 $ 10,000,000 $ 11,500,000 $ 10,000,000
Operating Profit $ 18,000,000 $ 18,400,000 $ 16,500,000 $ 13,800,000
operating
leverage 19% 21%