DIVISION B OF DILLARD, INC. Income Statement For the Year Ended December 31, 2018 Product Line T205 B179 Total Net Sales Revenue $ 310,000 $ 360,000 $ 670,000 Cost of Goods Sold: Variable 31,000 44,000 75,000 Fixed 275,000 67,000 342,000 Total Cost of Goods Sold 306,000 111,000 417,000 Gross Profit 4,000 249,000 253,000 Selling and Administrative Expenses: Variable 68,000 80,000 148,000 Fixed 47,000 27,000 74,000 Total Selling and Administrative Expenses 115,000 107,000 222,000 Operating Income (Loss) $ (111,000) $ 142,000 $ 31,000
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
Darren Dillard, majority stockholder and president of Dillard, Inc., is working with his top managers on future plans for the company. As the company’s
Requirements
- Division A of Dillard, Inc. has $5,250,000 in assets. Its yearly fixed costs are $557,000, and the variable costs of its product line are $1.90 per unit. The division’s volume is currently 500,000 units. Competitors offer a similar product, at the same quality, to retailers for $4.25 each. Dillard’s management team wants to earn a 12%
return on investment on the divisions assets.
- What is Division A’s target full product cost?
- Given the division’s current costs, will Division A be able to achieve its target profit?
- Assume Division A has identified ways to cut its variable costs to $1.75 per unit. What is its new target fixed cost? Will this decrease in variable costs allow the division to achieve its target profit?
2. The division manager of Division B received the following operating income data for the past year:
The manager of the division is surprised that the T205 product line is not profitable. The division accountant estimates that dropping the T205 product line will decrease fixed cost of goods sold by $75,000 and decrease fixed selling and administrative expenses by $10,000.
- Prepare a differential analysis to show whether Division B should drop the T205 product line.
- What is your recommendation to the manager of Division B?
3.Division C also produces two product lines. Because the division can sell all of the product it can produce, Dillard is expanding the plant and needs to decide which product line to emphasize. To make this decision, the division accountant assembled the following data:
After expansion, the factory will have a production capacity of 4,700 machine hours per month. The plant can manufacture cither 40 units of K707s or 62 units of G582s per machine hour.
- Identify the constraining factor for Division C.
- Prepare an analysis to show which product line to emphasize.
4. Division D is considering two possible expansion plans. Plan A would expand a current product line at a cost of $8,600,000. Expected annual net
- Compute the payback, the ARR, the
NPV , and the profitability index for both plans. - Compute the estimated
IRR of Plan A. - Use Excel to verify the NPV calculations in Requirement 4(a) and the actual IRR for the two plans. How does the IRR of each plan compare with the company’s required
rate of return ? - Division D must rank the plans and make a recommendation to Dillard’s top management team for the best plan. Which expansion plan should Division D choose? Why?
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