Chapter 12, Problem 12.28P

To determine

Concept Introduction:

Contribution margin

It is the difference between total revenue and variable expenses. Contribution margin equals the amount that sales exceed variable costs. It measures how efficiently a company can produce products and maintain low levels of variable cost.

  

Contribution margin, when expressed in percentage form is known as Contribution margin ratio and can be calculated as follows:

  

Breakeven point

It measures whether a project will be profitable by equating its total revenues with its total expenses. At break- even point, contribution margin equals fixed expenses which can be depicted as:

  

Break- even point in terms of sales dollars can be computed using the following formula:

  

Variable expenses

The expenses which are associated with the amount of goods produced or services provided. These vary directly with the production level i.e. company's variable cost increases as the production increases and vice-a-versa.

Fixed expenses

These expenses do not vary with the level of production. They do not change with the amount of goods or services a company produces. They remain same even if the company does not produce any product or provide any service during an accounting period.

Requirement a:

To calculate:

Current contribution margin ratio and break- even point in terms of revenues

Answer to Problem 12.28P

Current contribution margin ratio= 45%

Break- even point in terms of revenues= $6, 44,560

Explanation of Solution

To determine current contribution margin, below- mentioned formula would be used:

  

In the given problem, revenues are given as $8, 40,000, Variable expenses are given as $4, 62,000 and there are 1,500 units sold. Selling price can be calculated as follows:

  $\begin{array}{l}Sellingpriceperunit=Revenues/Numberofunitssold=\$8,40,000/1,500units\hfill \\ =\$560perunit\hfill \\ \hfill \\ Variablecostperunit=Variableexpenses/Numberofunitssold=\$4,62,000/1,500units\hfill \\ =\$308perunit\hfill \end{array}$

Contribution margin is given as $3, 78,000. Thus, current contribution margin ratio can be calculated using the following formula:

  

We have already calculated selling price is given as $560 per unit and Variable expenses as $308 per unit. Thus, contribution margin would be calculated using the below- mentioned formula:

  

  $Contributionmargin=\$560perunit-\$308perunit=\$252perunit$

At break- even point, contribution margin equals fixed expenses. Fixed expenses are given in the problem as $2, 90,000 per month. Let us assume number of units sold to be x.

  

  

Thus, break- even point in terms of sales volume= 1,151 units (rounded off).

Now, Break- even point in terms of sales dollars needs to be calculated. We have determined break- even point in terms of sales volume as 1,151 units and selling price per unit is given in the problem as $560 per unit. Therefore,

  

  

Thus, contribution margin ratio is coming out to be 45% and break- even point in terms of sales revenue as $6, 44,560.

To determine

Concept Introduction:

Contribution margin

It is the difference between total revenue and variable expenses. Contribution margin equals the amount that sales exceed variable costs. It measures how efficiently a company can produce products and maintain low levels of variable cost.

  

Contribution margin, when expressed in percentage form is known as Contribution margin ratio and can be calculated as follows:

  

Breakeven point

It measures whether a project will be profitable by equating its total revenues with its total expenses. At break- even point, contribution margin equals fixed expenses which can be depicted as:

  

Break- even point in terms of sales dollars can be computed using the following formula:

  

Variable expenses

The expenses which are associated with the amount of goods produced or services provided. These vary directly with the production level i.e. company's variable cost increases as the production increases and vice-a-versa.

Fixed expenses

These expenses do not vary with the level of production. They do not change with the amount of goods or services a company produces. They remain same even if the company does not produce any product or provide any service during an accounting period.

Requirement b:

To calculate:

Contribution margin ratio and break- even point in terms of revenues if new machine is leased

Answer to Problem 12.28P

Contribution margin ratio= 50%

Break- even point in terms of revenues= $6, 40,000

Explanation of Solution

Selling price per unit has already been calculated as $560 per unit and Variable cost as $308 per unit. A savings of $28 has been affected in labor costs, making variable cost as $280 per unit. There has been 20% increase in sales volume, making total sales as 1,800 units now. Following would be the calculations required:

  $\begin{array}{l}Sales=Numberofunitssold*Sellingpriceperunit=1,800units*\$560perunit\hfill \\ =\$10,08,000\hfill \\ Variableexpenses=Numberofunitssold*Variablecostperunit=1,800units*\$280perunit\hfill \\ =\$5,04,000\hfill \end{array}$

Contribution margin would be calculated using below- mentioned formula:

  

  $=\$10,08,000-\$5,04,000=\$5,04,000$

Thus, current contribution margin ratio can be calculated using the following formula:

  

At break- even point, contribution margin equals fixed expenses. Fixed expenses increased by $30,000, thereby making total fixed expenses as $3, 20,000 per month. Let us assume number of units sold to be x.

  

  

Thus, break- even point in terms of sales volume= 1,143 units (rounded off).

Now, Break- even point in terms of sales dollars needs to be calculated. We have determined break- even point in terms of sales volume as 1,143 units and selling price per unit is given in the problem as $560 per unit. Therefore,

  

  

Thus, contribution margin ratio is coming out to be 50% and break- even point in terms of sales revenue as $6, 40,000.

To determine

Concept Introduction:

Breakeven point

It measures whether a project will be profitable by equating its total revenues with its total expenses. At break- even point, contribution margin equals fixed expenses which can be depicted as:

  

Break- even point in terms of sales dollars can be computed using the following formula:

  

Contribution margin

It is the difference between total revenue and variable expenses. Contribution margin equals the amount that sales exceed variable costs. It measures how efficiently a company can produce products and maintain low levels of variable cost.

  

Variable expenses

The expenses which are associated with the amount of goods produced or services provided. These vary directly with the production level i.e. company's variable cost increases as the production increases and vice-a-versa.

Fixed expenses

These expenses do not vary with the level of production. They do not change with the amount of goods or services a company produces. They remain same even if the company does not produce any product or provide any service during an accounting period.

Requirement c:

To calculate:

Operating income of firm if new machine is leased

Answer to Problem 12.28P

Operating income of firm if new machine is leased= $1, 84,000

Explanation of Solution

We have already calculated Selling price per unit as $560 per unit, Variable cost as $280 per unit and sales volume as 1,800 units. Fixed expenses are given as $3, 20,000.

Sales have been calculated as $10, 08,000, Variable expenses as $5, 04,000 and Contribution margin as $5, 04,000. Thus, operating income would be:

  

All the above calculations can be seen from the table given below:

Calculation of operating income of Austin Inc. (Amount in $)

Particulars	Per unit	Sales Volume	Amount
Revenue	560	1,800 units	10,08,000
Less: Variable expenses	(280)	1,800 units	(5,04,000)
Contribution margin	280	1,800 units	5,04,000
Less: Fixed expenses			(3,20,000)
Operating income			1,84,000

Thus, operating income if new machine is leased is coming out to be $1, 84,000.

To determine

Concept Introduction:

Contribution margin

It is the difference between total revenue and variable expenses. Contribution margin equals the amount that sales exceed variable costs. It measures how efficiently a company can produce products and maintain low levels of variable cost.

  

Variable expenses

The expenses which are associated with the amount of goods produced or services provided. These vary directly with the production level i.e. company's variable cost increases as the production increases and vice-a-versa.

Fixed expenses

These expenses do not vary with the level of production. They do not change with the amount of goods or services a company produces. They remain same even if the company does not produce any product or provide any service during an accounting period.

Requirement d:

Whether new machine should be leased or not

Answer to Problem 12.28P

Austin Inc. should lease the new machine

Explanation of Solution

As can be seen from the calculations made above, there has been an increase in the operating income of Austin Inc. by leasing the new machine.

Earlier, the firm was earning $88,000 as operating income but by leasing the new machine, operating income of $1,84,000 has been earned which is $96,000 ($1,84,000- $88,000) more than the previous operating income earned. Therefore, Austin Inc. should lease the new machine.