# 3.7: Summary

- Page ID
- 10425

## Section Summaries

**3.1** Explain Contribution Margin and Calculate Contribution Margin per Unit, Contribution Margin Ratio, and Total Contribution Margin

**3.1**Explain Contribution Margin and Calculate Contribution Margin per Unit, Contribution Margin Ratio, and Total Contribution Margin

- Contribution margin can be used to calculate how much of every dollar in sales is available to cover fixed expenses and contribute to profit.
- Contribution margin can be expressed on a per-unit basis, as a ratio, or in total.
- A specialized income statement, the Contribution Margin Income Statement, can be useful in looking at total sales and total contribution margin at varying levels of activity.

**3.2** Calculate a Break-Even Point in Units and Dollars

**3.2**Calculate a Break-Even Point in Units and Dollars

- Break-even analysis is a tool that almost any business can use for planning and evaluation purposes. It helps identify a level of activity that is necessary before an organization starts to generate a profit.
- A break-even point can be found on a per-unit basis or as a dollar amount, depending upon whether a per-unit contribution margin or a contribution margin ratio is applied.

**3.3** Perform Break-Even Sensitivity Analysis for a Single Product Under Changing Business Situations

**3.3**Perform Break-Even Sensitivity Analysis for a Single Product Under Changing Business Situations

- Cost-volume-profit analysis can be used to conduct a sensitivity analysis that shows what will happen if there are changes in any of the variables: sales price, units sold, variable cost per unit, or fixed costs.
- The break-even point may or may not be impacted by changes in costs depending on the type of cost affected.

**3.4** Perform Break-Even Sensitivity Analysis for a Multi-Product Environment Under Changing Business Situations

**3.4**Perform Break-Even Sensitivity Analysis for a Multi-Product Environment Under Changing Business Situations

- Companies provide multiple products, goods, and services to the consumer and, as result, need to calculate their break-even point based on the mix of the products, goods, and services.
- In a multi-product environment, calculating the break-even point is more complex and is usually calculated using a composite unit, which represents the sales mix of the business.
- If the sales mix of a company changes, then the break-even point changes, regardless of whether total sales dollars change or not.

**3.5** Calculate and Interpret a Company’s Margin of Safety and Operating Leverage

**3.5**Calculate and Interpret a Company’s Margin of Safety and Operating Leverage

- Businesses determine a margin of safety (sales dollars beyond the break-even point). The higher the margin of safety is, the lower the risk is of not breaking even and incurring a loss.
- Operating leverage is a measurement of how sensitive net operating income is to a percentage change in sales dollars. A high degree of operating leverage results from a cost structure that is heavily weighted in fixed costs.

## Key Terms

**break-even point**- dollar amount (total sales dollars) or production level (total units produced) at which the company has recovered all variable and fixed costs; it can also be expressed as that point where Total Cost (TC) = Total Revenue (TR)

**composite unit**- selection of discrete products associated together in relation or proportion to their sales mix

**contribution margin**- amount by which a product’s selling price exceeds its total variable cost per unit

**contribution margin ratio**- percentage of a unit’s selling price that exceeds total unit variable costs

**margin of safety**- difference between current sales and break-even sales

**multi-product environment**- business environment in which a company sells different products, manufactures different products, or offers different types of services

**multiplier effect**- when the change in an input by a certain percentage has a greater effect (a higher percentage effect) on the output

**operating leverage**- measurement of how sensitive net operating income is to a percentage change in sales dollars

**relevant range**- quantitative range of units that can be produced based on the company’s current productive assets; for example, if a company has sufficient fixed assets to produce up to 10,000 units of product, the relevant range would be between 0 and 10,000 units

**sales mix**- relative proportions of the products that a company sells

**sensitivity analysis**- what will happen if sales price, units sold, variable cost per unit, or fixed costs change

**target pricing**- process in which a company uses market analysis and production information to determine the maximum price customers are willing to pay for a good or service in addition to the markup percentage

**total contribution margin**- amount by which total sales exceed total variable costs

## Multiple Choice

**1**.

__ LO 3.1__The amount of a unit’s sales price that helps to cover fixed expenses is its ________.

- contribution margin
- profit
- variable cost
- stepped cost

**2**.

__ LO 3.1__A company’s product sells for $150 and has variable costs of $60 associated with the product. What is its contribution margin per unit?

- $40
- $60
- $90
- $150

**3**.

__ LO 3.1__A company’s product sells for $150 and has variable costs of $60 associated with the product. What is its contribution margin ratio?

- 10%
- 40%
- 60%
- 90%

**4**.

__ LO 3.1__A company’s contribution margin per unit is $25. If the company increases its activity level from 200 units to 350 units, how much will its total contribution margin increase?

- $1,250
- $3,750
- $5,000
- $8,750

**5**.

__ LO 3.2__A company sells its products for $80 per unit and has per-unit variable costs of $30. What is the contribution margin per unit?

- $30
- $50
- $80
- $110

**6**.

__ LO 3.2__If a company has fixed costs of $6,000 per month and their product that sells for $200 has a contribution margin ratio of 30%, how many units must they sell in order to break even?

- 100
- 180
- 200
- 2,000

**7**.

__ LO 3.2__Company A wants to earn $5,000 profit in the month of January. If their fixed costs are $10,000 and their product has a per-unit contribution margin of $250, how many units must they sell to reach their target income?

- 20
- 40
- 60
- 120

**8**.

__ LO 3.2__A company wants to earn an income of $60,000 after-taxes. If the tax rate is 32%, what must be the company’s pre-tax income in order to have $60,000 after-taxes?

- $88,235
- $19,200
- $79,200
- $143,000

**9**.

__ LO 3.2__A company has pre-tax or operating income of $120,000. If the tax rate is 40%, what is the company’s after-tax income?

- $300,000
- $240,000
- $48,000
- $72,000

**10**.

__ LO 3.3__When sales price increases and all other variables are held constant, the break-even point will ________.

- remain unchanged
- increase
- decrease
- produce a lower contribution margin

**11**.

__ LO 3.3__When sales price decreases and all other variables are held constant, the break-even point will ________.

- remain unchanged
- increase
- decrease
- produce a higher contribution margin

**12**.

__ LO 3.3__When variable costs increase and all other variables remain unchanged, the break-even point will ________.

- remain unchanged
- increase
- decrease
- produce a lower contribution margin

**13**.

__ LO 3.3__When fixed costs decrease and all other variables remain unchanged, the break-even point will ________.

- remain unchanged
- increase
- decrease
- produce a lower contribution margin

**14**.

__ LO 3.3__When fixed costs increase and all other variables remain unchanged, the contribution margin will ________.

- remain unchanged
- increase
- decrease
- increase variable costs per unit

**15**.

__ LO 3.4__If the sales mix in a multi-product environment shifts to a higher volume in low contribution margin products, the break-even point will ________.

- remain unchanged because all products are included in the calculation of break-even
- increase because the low contribution margin products have little effect on break-even
- increase because the per composite unit contribution margin will decrease
- decrease because the per composite unit contribution margin will increase

**16**.

__ LO 3.4__Break-even for a multiple product firm ________.

- can be calculated by dividing total fixed costs by the contribution margin of a composite unit
- can be calculated by multiplying fixed costs by the contribution margin ratio of a composite unit
- can only be calculated when the proportion of products sold is the same for all products
- can be calculated by multiplying fixed costs by the contribution margin ratio of the most common product in the sales mix

**17**.

__ LO 3.4__Waskowski Company sells three products (A, B, and C) with a sales mix of 3:2:1. Unit sales price are shown. What is the sales price per composite unit?

- $17.00
- $25.00
- $35.00
- $20.00

**18**.

__ LO 3.4__Beaucheau Farms sells three products (E, F, and G) with a sale mix ratio of 3:1:2. Unit sales price are shown. What is the sales price per composite unit?

- $28.00
- $20.00
- $59.00
- $41.00

**19**.

__ LO 3.4__A company sells two products, Model 101 and Model 202. For every one unit of Model 101, they sell they sell two units of Model 202. Sales and cost information for the two products is shown. What is the contribution margin for a composite unit based on the sales mix?

- $14
- $21
- $35
- $56

**20**.

__ LO 3.5__Wallace Industries has total contribution margin of $58,560 and net income of $24,400 for the month of April. Wallace expects sales volume to increase by 5% in May. What are the degree of operating leverage and the expected percent change in income for Wallace Industries?

- 0.42 and 2.2%
- 0.42 and 5%
- 2.4 and 12%
- 2.5 and 13%

**21**.

__ LO 3.5__Macom Manufacturing has total contribution margin of $61,250 and net income of $24,500 for the month of June. Marcus expects sales volume to increase by 10% in July. What are the degree of operating leverage and the expected percent change in income for Macom Manufacturing?

- 0.4 and 10%
- 2.5 and 10%
- 2.5 and 25%
- 5.0 and 50%

**22**.

__ LO 3.5__If a firm has a contribution margin of $59,690 and a net income of $12,700 for the current month, what is their degree of operating leverage?

- 0.18
- 1.18
- 2.4
- 4.7

**23**.

__ LO 3.5__If a firm has a contribution margin of $78,090 and a net income of $13,700 for the current month, what is their degree of operating leverage?

- 0.21
- 1.21
- 2.4
- 5.7

## Questions

**1**.

__ LO 3.1__Define and explain contribution margin on a per unit basis.

**2**.

__ LO 3.1__Define and explain contribution margin ratio.

**3**.

__ LO 3.1__Explain how a contribution margin income statement can be used to determine profitability.

**4**.

__ LO 3.2__In a cost-volume-profit analysis, explain what happens at the break-even point and why companies do not want to remain at the break-even point.

**5**.

__ LO 3.2__What is meant by a product’s contribution margin ratio and how is this ratio useful in planning business operations?

**6**.

__ LO 3.3__Explain how a manager can use CVP analysis to make decisions regarding changes in operations or pricing structure.

**7**.

__ LO 3.3__After conducting a CVP analysis, most businesses will then recreate a revised or projected income statement incorporating the results of the CVP analysis. What is the benefit of taking this extra step in the analysis?

**8**.

__ LO 3.3__Explain how it is possible for costs to change without changing the break-even point.

**9**.

__ LO 3.4__Explain what a sales mix is and how changes in the sales mix affect the break-even point.

**10**.

__ LO 3.4__Explain how break-even analysis for a multi-product company differs from a company selling a single product.

**11**.

__ LO 3.5__Explain margin of safety and why it is an important measurement for managers.

**12**.

__ LO 3.5__Define operating leverage and explain its importance to a company and how it relates to risk.

## Exercise Set A

**1**.

__ LO 3.1__Calculate the per-unit contribution margin of a product that has a sale price of $200 if the variable costs per unit are $65.

**2**.

__ LO 3.1__Calculate the per-unit contribution margin of a product that has a sale price of $400 if the variable costs per unit are $165.

**3**.

__ LO 3.1__A product has a sales price of $150 and a per-unit contribution margin of $50. What is the contribution margin ratio?

**4**.

__ LO 3.1__A product has a sales price of $250 and a per-unit contribution margin of $75. What is the contribution margin ratio?

**5**.

__ LO 3.2__Maple Enterprises sells a single product with a selling price of $75 and variable costs per unit of $30. The company’s monthly fixed expenses are $22,500.

- What is the company’s break-even point in units?
- What is the company’s break-even point in dollars?
- Construct a contribution margin income statement for the month of September when they will sell 900 units.
- How many units will Maple need to sell in order to reach a target profit of $45,000?
- What dollar sales will Maple need in order to reach a target profit of $45,000?
- Construct a contribution margin income statement for Maple that reflects $150,000 in sales volume.

**6**.

__ LO 3.2__Marlin Motors sells a single product with a selling price of $400 with variable costs per unit of $160. The company’s monthly fixed expenses are $36,000.

- What is the company’s break-even point in units?
- What is the company’s break-even point in dollars?
- Prepare a contribution margin income statement for the month of November when they will sell 130 units.
- How many units will Marlin need to sell in order to realize a target profit of $48,000?
- What dollar sales will Marlin need to generate in order to realize a target profit of $48,000?
- Construct a contribution margin income statement for the month of February that reflects $200,000 in sales revenue for Marlin Motors.

**7**.

__ LO 3.3__Flanders Manufacturing is considering purchasing a new machine that will reduce variable costs per part produced by $0.15. The machine will increase fixed costs by $18,250 per year. The information they will use to consider these changes is shown here.

**8**.

__ LO 3.3__Marchete Company produces a single product. They have recently received the results of a market survey that indicates that they can increase the retail price of their product by 8% without losing customers or market share. All other costs will remain unchanged. Their most recent CVP analysis is shown. If they enact the 8% price increase, what will be their new break-even point in units and dollars?

**9**.

__ LO 3.3__Brahma Industries sells vinyl replacement windows to home improvement retailers nationwide. The national sales manager believes that if they invest an additional $25,000 in advertising, they would increase sales volume by 10,000 units. Prepare a forecasted contribution margin income statement for Brahma if they incur the additional advertising costs, using this information:

**10**.

__ LO 3.4__Salvador Manufacturing builds and sells snowboards, skis and poles. The sales price and variable cost for each are shown:

Their sales mix is reflected in the ratio 7:3:2. What is the overall unit contribution margin for Salvador with their current product mix?

**11**.

__ LO 3.4__Salvador Manufacturing builds and sells snowboards, skis and poles. The sales price and variable cost for each follows:

Their sales mix is reflected in the ratio 7:3:2. If annual fixed costs shared by the three products are $196,200, how many units of each product will need to be sold in order for Salvador to break even?

**12**.

__ LO 3.4__Use the information from

__involving Salvador Manufacturing to determine their break-even point in sales dollars.__

**the previous exercises****13**.

__ LO 3.5__Company A has current sales of $10,000,000 and a 45% contribution margin. Its fixed costs are $3,000,000. Company B is a service firm with current service revenue of $5,000,000 and a 20% contribution margin. Company B’s fixed costs are $500,000. Compute the degree of operating leverage for both companies. Which company will benefit most from a 25% increase in sales? Explain why.

**14**.

__ LO 3.5__Marshall & Company produces a single product and recently calculated their break-even point as shown.

What would Marshall’s target margin of safety be in units and dollars if they required a $14,000 margin of safety?

## Exercise Set B

**1**.

__ LO 3.1__Calculate the per-unit contribution margin of a product that has a sale price of $150 if the variable costs per unit are $40.

**2**.

__ LO 3.1__Calculate the per-unit contribution margin of a product that has a sale price of $350 if the variable costs per unit are $95.

**3**.

__ LO 3.1__A product has a sales price of $175 and a per-unit contribution margin of $75. What is the contribution margin ratio?

**4**.

__ LO 3.1__A product has a sales price of $90 and a per-unit contribution margin of $30. What is the contribution margin ratio?

**5**.

__ LO 3.2__Cadre, Inc., sells a single product with a selling price of $120 and variable costs per unit of $90. The company’s monthly fixed expenses are $180,000.

- What is the company’s break-even point in units?
- What is the company’s break-even point in dollars?
- Prepare a contribution margin income statement for the month of October when they will sell 10,000 units.
- How many units will Cadre need to sell in order to realize a target profit of $300,000?
- What dollar sales will Cadre need to generate in order to realize a target profit of $300,000?
- Construct a contribution margin income statement for the month of August that reflects $2,400,000 in sales revenue for Cadre, Inc.

**6**.

__ LO 3.2__Kerr Manufacturing sells a single product with a selling price of $600 with variable costs per unit of $360. The company’s monthly fixed expenses are $72,000.

- What is the company’s break-even point in units?
- What is the company’s break-even point in dollars?
- Prepare a contribution margin income statement for the month of January when they will sell 500 units.
- How many units will Kerr need to sell in order to realize a target profit of $120,000?
- What dollar sales will Kerr need to generate in order to realize a target profit of $120,000?
- Construct a contribution margin income statement for the month of June that reflects $600,000 in sales revenue for Kerr Manufacturing.

**7**.

__ LO 3.2__Delta Co. sells a product for $150 per unit. The variable cost per unit is $90 and fixed costs are $15,250. Delta Co.’s tax rate is 36% and the company wants to earn $44,000 after taxes.

- What would be Delta’s desired pre-tax income?
- What would be break-even point in units to reach the income goal of $44,000 after taxes?
- What would be break-even point in sales dollars to reach the income goal of $44,000 after taxes?
- Create a contribution margin income statement to show that the break-even point calculated in B, generates the desired after-tax income.

**8**.

__ LO 3.3__Shonda & Shonda is a company that does land surveys and engineering consulting. They have an opportunity to purchase new computer equipment that will allow them to render their drawings and surveys much more quickly. The new equipment will cost them an additional $1,200 per month, but they will be able to increase their sales by 10% per year. Their current annual cost and break-even figures are as follows:

- What will be the impact on the break-even point if Shonda & Shonda purchases the new computer?
- What will be the impact on net operating income if Shonda & Shonda purchases the new computer?
- What would be your recommendation to Shonda & Shonda regarding this purchase?

**9**.

__ LO 3.3__Baghdad Company produces a single product. They have recently received the result of a market survey that indicates that they can increase the retail price of their product by 10% without losing customers or market share. All other costs will remain unchanged. If they enact the 10% price increase, what will be their new break-even point in units and dollars? Their most recent CVP analysis is:

**10**.

__ LO 3.3__Keleher Industries manufactures pet doors and sells them directly to the consumer via their web site. The marketing manager believes that if the company invests in new software, they will increase their sales by 10%. The new software will increase fixed costs by $400 per month. Prepare a forecasted contribution margin income statement for Keleher Industries reflecting the new software cost and associated increase in sales. The previous annual statement is as follows:

**11**.

__ LO 3.4__JJ Manufacturing builds and sells switch harnesses for glove boxes. The sales price and variable cost for each follows:

Their sales mix is reflected in the ratio 4:4:1. What is the overall unit contribution margin for JJ Manufacturing with their current product mix?

**12**.

__ LO 3.4__JJ Manufacturing builds and sells switch harnesses for glove boxes. The sales price and variable cost for each follow:

Their sales mix is reflected in the ratio 4:4:1. If annual fixed costs shared by the three products are $18,840 how many units of each product will need to be sold in order for JJ to break even?

**13**.

__ LO 3.4__Use the information from

__involving JJ Manufacturing to determine their break-even point in sales dollars.__

**the previous exercises****14**.

__ LO 3.5__Company A has current sales of $4,000,000 and a 45% contribution margin. Its fixed costs are $600,000. Company B is a service firm with current service revenue of $2,800,000 and a 15% contribution margin. Company B’s fixed costs are $375,000. Compute the degree of operating leverage for both companies. Which company will benefit most from a 15% increase in sales? Explain why.

**15**.

__ LO 3.5__Best Wholesale recently calculated their break-even point for their Midwest operations. The national sales manager has asked them to include a $10,500 margin of safety in their calculations. Using the following information, recalculate Best Wholesale’s break-even point in units and dollars with the $10,500 margin of safety included.

## Problem Set A

**1**.

__ LO 3.1__A company sells small motors as a component part to automobiles. The Model 101 motor sells for $850 and has per-unit variable costs of $400 associated with its production. The company has fixed expenses of $90,000 per month. In August, the company sold 425 of the Model 101 motors.

- Calculate the contribution margin per unit for the Model 101.
- Calculate the contribution margin ratio of the Model 101.
- Prepare a contribution margin income statement for the month of August.

**2**.

__ LO 3.1__A company manufactures and sells racing bicycles to specialty retailers. The Bomber model sells for $450 and has per-unit variable costs of $200 associated with its production. The company has fixed expenses of $40,000 per month. In May, the company sold 225 of the Bomber model bikes.

- Calculate the contribution margin per unit for the Bomber.
- Calculate the contribution margin ratio of the Bomber.
- Prepare a contribution margin income statement for the month of May.

**3**.

__ LO 3.2__Fill in the missing amounts for the four companies. Each case is independent of the others. Assume that only one product is being sold by each company.

**4**.

__ LO 3.2__Markham Farms reports the following contribution margin income statement for the month of August. The company has the opportunity to purchase new machinery that will reduce its variable cost per unit by $2 but will increase fixed costs by 15%. Prepare a projected contribution margin income statement for Markham Farms assuming it purchases the new equipment. Assume sales level remains unchanged.

**5**.

__ LO 3.3__Kylie’s Cookies is considering the purchase of a larger oven that will cost $2,200 and will increase her fixed costs by $59. What would happen if she purchased the new oven to realize the variable cost savings of $0.10 per cookie, and what would happen if she raised her price by just $0.20? She feels confident that such a small price increase will decrease the sales by only 25 units and may help her offset the increase in fixed costs. Given the following current prices how would the break-even in units and dollars change if she doesn’t increase the selling price and if she does increase the selling price? Complete the monthly contribution margin income statement for each of these cases.

**6**.

__ LO 3.4__Morris Industries manufactures and sells three products (AA, BB, and CC). The sales price and unit variable cost for the three products are as follows:

Their sales mix is reflected as a ratio of 5:3:2. Annual fixed costs shared by the three products are $258,000 per year.

- What are total variable costs for Morris with their current product mix?
- Calculate the number of units of each product that will need to be sold in order for Morris to break even.
- What is their break-even point in sales dollars?
- Using an income statement format, prove that this is the break-even point.

**7**.

__ LO 3.4__Manatoah Manufacturing produces 3 models of window air conditioners: model 101, model 201, and model 301. The sales price and variable costs for these three models are as follows:

The current product mix is 4:3:2. The three models share total fixed costs of $430,000.

- Calculate the sales price per composite unit.
- What is the contribution margin per composite unit?
- Calculate Manatoah’s break-even point in both dollars and units.
- Using an income statement format, prove that this is the break-even point.

**8**.

__ LO 3.5__Jakarta Company is a service firm with current service revenue of $400,000 and a 40% contribution margin. Its fixed costs are $80,000. Maldives Company has current sales of $6,610,000 and a 45% contribution margin. Its fixed costs are $1,800,000.

- What is the margin of safety for Jakarta and Maldives?
- Compare the margin of safety in dollars between the two companies. Which is stronger?
- Compare the margin of safety in percentage between the two companies. Now, which one is stronger?
- Compute the degree of operating leverage for both companies. Which company will benefit most from a 15% increase in sales? Explain why. Illustrate your findings in an Income Statement that is increased by 15%.

## Problem Set B

**1**.

__ LO 3.1__A company sells mulch by the cubic yard. Grade A much sells for $150 per cubic yard and has variable costs of $65 per cubic yard. The company has fixed expenses of $15,000 per month. In August, the company sold 240 cubic yards of Grade A mulch.

- Calculate the contribution margin per unit for Grade A mulch.
- Calculate the contribution margin ratio of the Grade A mulch.
- Prepare a contribution margin income statement for the month of August.

**2**.

__ LO 3.1__A company manufactures and sells blades that are used in riding lawnmowers. The 18-inch blade sells for $15 and has per-unit variable costs of $4 associated with its production. The company has fixed expenses of $85,000 per month. In January, the company sold 12,000 of the 18-inch blades.

- Calculate the contribution margin per unit for the 18-inch blade.
- Calculate the contribution margin ratio of the 18-inch blade.
- Prepare a contribution margin income statement for the month of January.

**3**.

__ LO 3.2__Fill in the missing amounts for the four companies. Each case is independent of the others. Assume that only one product is being sold by each company.

**4**.

__ LO 3.2__West Island distributes a single product. The company’s sales and expenses for the month of June are shown.

Using the information presented, answer these questions:

- What is the break-even point in units sold and dollar sales?
- What is the total contribution margin at the break-even point?
- If West Island wants to earn a profit of $21,000, how many units would they have to sell?
- Prepare a contribution margin income statement that reflects sales necessary to achieve the target profit.

**5**.

__ LO 3.2__Wellington, Inc., reports the following contribution margin income statement for the month of May. The company has the opportunity to purchase new machinery that will reduce its variable cost per unit by $10 but will increase fixed costs by 20%. Prepare a projected contribution margin income statement for Wellington, Inc., assuming it purchases the new equipment. Assume sales level remains unchanged.

**6**.

__ LO 3.3__Karen’s Quilts is considering the purchase of a new Long-arm Quilt Machine that will cost $17,500 and will increase her fixed costs by $119. What would happen if she purchased the new quilt machine to realize the variable cost savings of $5.00 per quilt, and what would happen if she raised her price by just $5.00? She feels confident that such a small price increase will not decrease the sales in units that will help her offset the increase in fixed costs. Given the following current prices how would the break-even in units and dollars change? Complete the monthly contribution margin income statement for each of these cases.

**7**.

__ LO 3.4__Abilene Industries manufactures and sells three products (XX, YY, and ZZ). The sales price and unit variable cost for the three products are as follows:

Their sales mix is reflected as a ratio of 4:2:1. Annual fixed costs shared by the three products are $345,000 per year.

- What are total variable costs for Abilene with their current product mix?
- Calculate the number of units of each product that will need to be sold in order for Abilene to break even.
- What is their break-even point in sales dollars?
- Using an income statement format, prove that this is the break-even point.

**8**.

__ LO 3.4__Tim-Buck-II rents jet skis at a beach resort. There are three models available to rent: Junior, Adult, and Expert. The rental price and variable costs for these three models are as follows:

The current product mix is 5:4:1. The three models share total fixed costs of $114,750

- Calculate the sales price per composite unit.
- What is the contribution margin per composite unit?
- Calculate Tim-Buck-II’s break-even point in both dollars and units.
- Using an income statement format, prove that this is the break-even point.

**9**.

__ LO 3.5__Fire Company is a service firm with current service revenue of $900,000 and a 40% contribution margin. Its fixed costs are $200,000. Ice Company has current sales of $420,000 and a 30% contribution margin. Its fixed costs are $90,000.

- What is the margin of safety for Fire and Ice?
- Compare the margin of safety in dollars between the two companies. Which is stronger?
- Compare the margin of safety in percentage between the two companies. Now which one is stronger?
- Compute the degree of operating leverage for both companies. Which company will benefit most from a 10% increase in sales? Explain why. Illustrate your findings in an Income Statement that is increased by 10%.

## Thought Provokers

**1**.

__ LO 3.1__Mariana Manufacturing and Bellow Brothers compete in the same industry and in all respects their products are virtually identical. However, most of Mariana’s costs are fixed while Bellow’s costs are primarily variable. If sales increase for both companies, which will realize the greatest increase in profits? Why?

**2**.

__ LO 3.2__Roald is the sales manager for a small regional manufacturing firm you own. You have asked him to put together a plan for expanding into nearby markets. You know that Roald’s previous job had him working closely with many of your competitors in this new market, and you believe he will be able to facilitate the company expansion. He is to prepare a presentation to you and your partners outlining his strategy for taking the company into this expanded market. The day before the presentation, Roald comes to you and explains that he will not be making a presentation on market expansion but instead wants to discuss several ways he believes the company can reduce both fixed and variable costs. Why would Roald want to focus on reducing costs rather than on expanding into a new market?

**3**.

__ LO 3.3__As a manager, you have to choose between two options for new production equipment. Machine A will increase fixed costs by a substantial margin but will produce greater sales volume at the current price. Machine B will only slightly increase fixed costs but will produce considerable savings on variable cost per unit. No additional sales are anticipated if Machine B is selected. What are the relative merits of both machines, and how could you go about analyzing which machine is the better investment for the company in terms of both net operating income and break-even?

**4**.

__ LO 3.5__Couture’s Creations is considering offering Joe, an hourly employee, the opportunity to become a salaried employee. Why is this a good idea for Couture’s Creations? Is this a good idea for Joe? What if Couture’s Creations entices Joe to agree to the change by offering him a salaried position with no risk of layoff during the winter lull? What if Joe agrees and Couture’s Creations lays him off anyway six months into the agreement?