A7-70
Select one product that you could make yourself. Examples of possible products could be cookies, birdhouses, jewelry, or custom t-shirts. Assume that you have decided to start a small business producing and selling this product. You will be applying the concepts of cost-volume-profit analysis to this potential venture.
Note: This is a sample solution. Student answers will vary.
CVP for a Product
Basic Discussion Questions
1. Describe your product. What market are you targeting this product for? What price will you sell your product for? Make projections of your sales in units over each of the upcoming five years.
I make beaded necklaces for women who are interested in unique, yet affordable accessories to their wardrobes. The necklaces will sell for an average of $100 each.
Sales Projections
2012 2013 2014 2015 2016
150 175 200 225 250
2. Make a detailed list of all of the materials needed to make your product.
Include quantities needed of each material. Also include the cost of the material on a per-unit basis.
Estimate the cost of each piece of equipment that you will need.
Equipment
Tools $100
Storage boxes for materials $75
Beading boards $50
Miscellaneous supplies $50
TOTAL $275
4. Make a list of all other expenses that would be needed to create your product.
Examples of other expenses would be rent, utilities, and insurance. Estimate the cost of each of these expenses per year.
Rent $1,800
Utilities $120
Insurance $50
TOTAL $1,970
5. Now classify all of the expenses you have listed as being either fixed or variable.
6. Calculate how many units of your product you will need to sell to breakeven in each of the five years you have projected.
Fixed expenses / Unit contribution margin = Unit breakeven point
$1,850 / ($100 - $27) = 26 necklaces
7. Calculate the margin of safety in units for each of the five years in your projection.
Margin of Safety = Projected Sales – Breakeven Sales
2012 2013 2014 2015 2016
150-26=124 175-26=149 200-26=174 225-26=199 250-26=224
$12,400 $14,900 $17,400 $19,900 $22,400
8. Now decide how much you would like to make in before-tax operating income (target profit) in each of the upcoming five years. Calculate how many units you would need to sell in each of the upcoming years to meet these target profit levels.
Fixed expenses + Target profit / Unit CM = Yearly sales volume
$1,850 + $12,000 / ($100 - $27) = 190 necklaces
9. How realistic is your potential venture? Do you think you would be able to break even in each of the projected five years? How risky is your venture (use the margin of safety to help answer this question). Do you think your target profits are achievable?
The venture looks realistic. The breakeven point is only 26 necklaces, which means I would need to sell on average less than three necklaces a month. The margin of safety is promising as long as the projected sales can be made. The target profits appear achievable, but will require implementing a solid marketing plan.
Student answers will vary.
(30 min.) A7-71 Ethics Mini-Case
1.
a. The ethical issues in this situation are:
Competence: “Provide decision support information and recommendations that are accurate, clear, concise, and timely.” In his initial report, Greg Michaels’ had an inaccuracy. It was a mistake, but ignoring the mistake is a breach of this principle.
Confidentiality: “Keep information confidential except when disclosure is authorized or legally required.” Greg Michaels’ disclosure of the internal report to Beth Sparrow, an employee of a competing company, is neither authorized nor legally required. As a result, this is a clear ethical violation.
Integrity: “Abstain from engaging in or supporting any activity that might discredit the profession.” Ignoring errors in reports which affect real business decisions could discredit the profession.
Credibility: “Disclose all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, analyses, or
recommendations.” It is reasonable to expect that the undisclosed error, if disclosed, would affect the understanding of the report. Thus, by not reporting this inaccuracy, Greg Michaels is violating this ethical principle.
b. Greg Michaels’ responsibilities as a management accountant are to be honest, fair, objective, and responsible. He should seek to correct the mistake he had made by reporting it to his immediate supervisor. He is also responsible for maintaining
confidential information, so he should not disclose confidential information to his friend, however much he may trust her.
c. John Hammond is responsible for reviewing the reports which are given to him before signing off on them, especially in the case of interns or junior employees. It is not sufficient that a report looks professional, but he has a duty to also verify that it is accurate.
d. Beth Sparrows is responsible for making ethical decisions. Since she is employed by a competing company, she should not look at Greg Michaels’ report, as it could result in unethical behavior. She should encourage Greg to take his concerns to his supervisor.
She may give him general advice but should not examine anything which is confidential.
2. By omitting the fixed monthly sales staff salaries from the report, breakeven sales are reported as lower than they actually are. This error would certainly influence the decision about proceeding with the new proposal, since it would make the proposal look favorable and more profitable than it actually is.
3. First, Greg should report the mistake with his immediate supervisor. If he has concerns about his employment with the firm after this mistake, he should take these concerns to the HR department to get an objective third party which is not involved in this incident.
(20-25 min.) A7-72 Real-life Mini Case
1. Is the cost of down a fixed cost or a variable cost for a jacket manufacturer such as Lands’ End?
Down is a variable cost to jacket manufacturers because more down is required for each additional unit (jacket) produced.
2. If the cost of down increases, what happens to the breakeven point for a down-filled jacket product line at Land’s End?
If the cost of down increases, the breakeven point will also increase because the contribution margin will decrease.
3. What is the percentage increase in the cost of down per pound from 2010 to 2012 at Land’s End? Would you expect the breakeven units to change by this same percentage? Why or why not?
The price of down increased by about 77% [($23 - $13)/$13]. The breakeven units will not change by this same percentage because down is only one material that goes into the cost of the jacket. If we assume that the other costs are assumed to have stayed the same, the actual total cost of making the jacket will increase by a smaller total percentage. Therefore, the breakeven in units will increase by a smaller amount than 77%.
4. If down increases by a certain percentage, will the selling price of a down-filled jacket need to change by that same percentage to maintain the same profit margin? Explain.
No. Again, down is only one component of the jacket. The other materials in the jacket will help to lessen the impact of the percentage increase in the cost of down (assuming those other materials remain at a constant cost.) Therefore, the selling price will not have to be increased by 77 percent to cope with the 77 percent increase in the cost of down.
5. Assume that a Land’s End down jacket selling for $100 uses 12 ounces of down.
Further assume that Lands’ End has $250,000 of fixed costs related to the down jacket line and its other variable manufacturing costs total $60 per jacket. As stated in the story, the cost per pound of down was $13 and $23 in October 2010 and October 2012, respectively. Calculate the breakeven number of jackets both in (a) October 2010; and (b) October 2012. Do these breakeven numbers agree with your answers to the prior questions?
October 2010 breakeven: $250,000 / ($100 – ($60 + ($13 x 12/16))) = 8,264 jackets (rounded)
October 2012 breakeven: $250,000 / ($100 – ($60 + ($23 x 12/16))) = 10,989 jackets (rounded)
Yes, these numbers agree to answers to the prior questions.
6. Assume now the same set of facts as in Question 5 but that Lands’ End raises the selling price of each jacket by $10 in October 2013. Does the contribution margin percentage remain the same?
No, the contribution margin would increase, this is because Lands’ End only uses 12 ounces of down in each jacket and the price per pound of down went up $10. Therefore, the $10 increase in price will overcompensate for the variable cost per unit increase of the jacket.
October 2010 contribution margin: $100 – ($60 + ($13 x 12/16)) = $69.75 October 2010 contribution margin ratio: $69.75 / $100 = 69.75%
October 2012 contribution margin: $110 – ($60 + ($23 x 12/16)) = $87.25 October 2012 contribution margin ratio: $87.25 / $110 = 79.32%