Chapter 6, Problem 6.2AP

Lorge Corporation has collected the following information after its first year of sales. Sales were $1,500,000 on 100,000 units; selling expenses $250,000 (40% variable and 60% fixed); direct materials $511,000; direct labor $290,000; administrative expenses $270,000 (20% variable and 80% fixed); and manufacturing overhead $350,000 (70% variable and 30% fixed). Top management has asked you to do a CVP analysis so that it can make plans for the coming year. It has projected that unit sales will increase by 10% next year.

Instructions

(a) Compute (1) the contribution margin for the current year and the projected year, and (2) the fixed costs for the current year. (Assume that fixed costs will remain the same in the projected year.)

(b) Compute the break-even point in units and sales dollars for the first year.

(c) The company has a target net income of $200,000. What is the required sales in dollars for the company to meet its target?

(d) If the company meets its target net income number, by what percentage could its sales fall before it is operating at a loss? That is, what is its margin of safety ratio?

(e) The company is considering a purchase of equipment that would reduce its direct labor costs by $104,000 and would change its manufacturing overhead costs to 30% variable and 70% fixed (assume total manufacturing overhead cost is $350,000, as above). It is also considering switching to a pure commission basis for its sales staff. This would change selling expenses to 90% variable and 10% fixed (assume total selling expense is $250,000, as above). Compute (1) the contribution margin and (2) the contribution margin ratio, and recompute (3) the break-even point in sales dollars. Comment on the effect each of managements proposed changes has on the break-even point.