Question

Exercise 5-17 Break-Even and Target Profit Analysis (LO5-4, LO5-5, LO5-6] Outback Outfitters sells recreational equipment. One of the company's products, a small camp stove, sells for $100 per unit. Variable expenses are $70 per stove, and fixed expenses associated with the stove total $129,000 per month. Required: 1. What is the break-even point in unit sales and in dollar sales? 2. If the variable expenses per stove increase as a percentage of the selling price, will it result in a higher or a lower break-even point? (Assume that the fixed expenses remain unchanged.) 3. At present, the company is selling 17,000 stoves per month. The sales manager is convinced that a 10% reduction in the selling price would result in a 25% increase in monthly sales of stoves. Prepare two contribution format income statements, one under present operating conditions, and one as operations would appear after the proposed changes. 4. Refer to the data in Required 3. How many stoves would have to be sold at the new selling price to attain a target profit of $79,000 per month? Complete this question by entering your answers in the tabs below. Required 1 Required 2 Required 3 Required 4 At present, the company is selling 17,000 stoves per month. The sales manager is convinced that a 10% reduction in the selling price would result in a 25% increase in monthly sales of stoves. Prepare two contribution format income statements, one under present operating conditions, and one as operations would appear after the proposed changes. Contribution Income Statement Outback Outfitters Present 17,000 Stoves Total Per unit Proposed Stoves Total Per unit

Answer 1

1. Calculation of Break-even point

Contribution Margin p.u = Sale price p.u - Variable Cost p.u = 100-70 = 30$ p.u

P/V Ratio or Contribution Margin ratio = (Contribution p.u / Sale price)*100 = (30/100)*100 = 30%

Fixed Costs = 129,000 $

Break-even point (in Units) = Fixed Cost / Contribution p.u = 129,000/30 = 4300 units

Break-even point (in Dollars) = Fixed Cost / PV Ratio = 129,000/30% = 430,000$

Answer to 2nd :

If variable expenses would increase as % of SP, our contribution per unit would decrease and since contribution reduces, our Break-even point will increase, i.e. a higher break-even point will be there.

Let's take the following example to prove our point:

Currently VC = 70% of SP

Let's assume VC increase to 80% of SP, i.e., Contribution now becomes 20$ p.u

Hence new break-even point is as follows :

Break-even point (in Units) = Fixed Cost / Contribution p.u = 129,000/20 = 6450 units

Break-even point (in Dollars) = Fixed Cost / PV Ratio = 129,000/20% = 645,000$

The above example proves that as VC increases, our break-even point will be higher.

Answer to 3rd :

Proposed Changes :

1. New SP = 90$

2. New sales figure = 17,000+(17,000*25%) = 21250

Contribution Income Statement

Present - 17,000 stoves

Proposed - 21,250 stoves

Total

Per Unit

Total

Per Unit

Sales

17,00,000

100

1912500

90

Variable expenses

11,90,000

70

1487500

70

Contribution Margin

5,10,000

30

4,25,000

20

Fixed Expenses

1,29,000

8

1,29,000

6

Net operating Income

3,81,000

22

2,96,000

14

Answer to 4th :

Sales in units if desired profit is 79,000 $ & SP is 90; Contribution is 20$

Unit Sales = (Fixed Costs + Target Profit) / Contribution Margin per unit

Unit Sales when target profit is 79,000 $ = (129,000 $ + 79,000 $) / 20$ p.u = 10,400 units

Sales in units if desired profit is 79,000 $ & SP is 100; Contribution is 30$

Unit Sales = (Fixed Costs + Target Profit) / Contribution Margin per unit

Unit Sales when target profit is 79,000 $ = (129,000 $ + 79,000 $) / 30$ p.u = 6,933 units