Question

Problem 11-29 Margin of safety and operating leverage LO 11-6 Gibson Company is considering the addition of a new product to its cosmetics line. The company has three distinctly different options a skin cream, a bath oil, or a hair coloring gel. Relevant information and budgeted annual income statements for each of the products follow Relevant Information Bath Oil Skin Cream 116,000 Color Gel Budgeted sales in units (a) Expected sales price (b) Variable costs per unit (c) Income statements Sales revenue (ax b) Variable costs (ax c) Contribution margin Fixed costs Net income 196,000 76,000 12 $ 812,000 (232,000) 580,000 $1,176,000 $912,000 304,000 $ 216,000 (588,000) 588,000 (608,000) (405,000(88,000) $ 175,000 183,000 Required a. Determine the margin of safety as a percentage for each product. b. Prepare revised income statements for each product, assuming a 20 percent increase in the budgeted sales volume c. For each product, determine the percentage change in net income that results from the 20 percent increase in sales d. Assuming that management is pessimistic and risk averse, which product should the company add to its cosmetics line? e. Assuming that management is optimistic and risk aggressive, which product should the company add to its cosmetics line? Complete this question by entering your answers in the tabs below. Req A Req B Req C Req D to E

Answer 1

Req A:

The margin of safety: Budgeted sales exceeds the break-even sales

Formulae:

The margin of Safety=Budgeted sales (or Actual)-Break even sales

Break Even point (in units) = Fixed cost/Contribution per unit

	Particulars	Skin Cream	Bath oil	Color Gel
a	Budgeted sales in units	116,000	196,000	76,000
b	expected sales price	$                 7	$                  6	$            12
c	Variable costs per unit	$                 2	$                  3	$               8
d	Revenues (Sales) (a*b)	$    812,000	$ 1,176,000	$ 912,000
e	Less:Variable Costs (a*c)	(232,000)	(588,000)	(608,000)
f	Contribution	580,000	588,000	304,000
g	Less:Fixed Cost	(405,000)	(405,000)	(88,000)
h	Operating Income	175,000	183,000	216,000
i	Contribution per unit (f/a)	5	3	4
j	Break Even Point ( in Units ) (g/i)	81,000	135,000	22,000
k	Break Even Point ( in Sales ) (j*B)	567,000	810,000	264,000
l	Margin of safety (in Sales) (d-k)	245,000	366,000	648,000
Req A		Skin Cream	Bath oil	Color Gel
m	Margin of safety [(l/d)*100]	30%	31%	71%

Req B

Req B		Skin Cream	Bath oil	Color Gel
a	Budgeted sales in units	139,200	235,200	91,200
b	expected sales price	$                 7	$                  6	$                12
c	Variable costs per unit	$                 2	$                  3	$                  8
d	Sales Revenue (a*b)	$    974,400	$ 1,411,200	$ 1,094,400
e	Less:Variable Costs (a*c)	(278,400)	(705,600)	(729,600)
f	Contribution Margin	696,000	705,600	364,800
g	Less:Fixed Cost	(405,000)	(405,000)	(405,000)
h	Net Income	291,000	300,600	(40,200)

Req C

Req C		Skin Cream	Bath oil	Color Gel
change in Net income		116,000	117,600	(256,200)
% of change in Net income		66%	64%	-119%

Req D to E

As if management is pessimistic and risk-averse it is better to add Color gel as their margin of safety is 71%

As if management is Optimistic and risk aggressive it is better to add Skin cream or Bath oil as their % of Change in income is more when compared to Color Gel