PROBLEM 1.

For two years, William Dibson has been the manager of the production department of a
company manufacturing toys made of plastic-coated cardboard. One of the toys is a paper doll,
whose "clothes" are made of acetate, and stay on the doll with static electricity. The company's
sales were mainly to large educational institutions until last year, when the dolls were sold for
the first time to a large discount retailer. The dolls were sold out immediately, and enough
orders were received to keep the department at full capacity for the immediate future.

The fixed costs for the department are $50,000, with $1 per unit variable costs. A paper doll and
one set of clothes sell for $3. The maximum volume is 80,000 units. With the increased volume,
Mr. Dibson is considering two options to improve profitability. One would reduce variable costs
to $0.75, and the other would reduce fixed costs to $35,000.

Required:
Given the fact that sales are increasing, make a short (one paragraph) recommendation to Mr.
Dibson about which option he should choose. Support your recommendation with a calculation
showing him how profitability will change with each option.
Solution 201
The variable costs should be reduced to $0.75 per unit in order to ensure maximum profitability
of the paper doll product line. The calculations are as follows:

Current Profit = ($3 × 80,000) – ($1 × 80,000) – $50,000

= $240,000 – $80,000 – $50,000
= $110,000

Plan #1: Reduce Variable Costs to $0.75

Profit = ($3 × 80,000) – ($0.75 × 80,000) – $50,000
= $240,000 – $60,000 – $50,000
= $130,000

Plan #2: Reduce Fixed Costs to $35,000

Profit = ($3 × 80,000) – ($1 × 80,000) – $35,000
= $240,000 – $80,000 – $35,000
= $125,000

PROBLEM 2
Sayler Company earned net income of $350,000 last year. This year it wants to earn net income
of $400,000. The company's fixed costs are expected to be $300,000, and variable costs are
expected to be 60% of sales.
Required:
(a) Determine the required sales to meet the target net income of $400,000 using the
mathematical equation.
(b) Using a CVP income statement format, prove your answer.

Solution:
(a) Sales = Variable Cost + Fixed Cost + Target Net Income

X = .60X + $300,000 + $400,000

.40X = $700,000
X = $1,750,000

Required Sales are $1,750,000.

(b) Sales $1,750,000

Variable costs 1,050,000
Contribution margin 700,000
Fixed costs 300,000
Target net income $ 400,000

PROBLEM 3
Quiltworks Company reported actual sales of $2,000,000, and fixed costs of $450,000. The
contribution margin ratio is 30%.
Required:
Compute the margin of safety in dollars and the margin of safety ratio.

Solution
Break-even point in dollars: $450,000 ÷ 30% = $1,500,000
Margin of safety in dollars: $2,000,000 – $1,500,000 = $500,000
Margin of safety ratio: $500,000 ÷ $2,000,000 = 25%

PROBLEM 4

Spears Music, Inc. produces a hip-hop CD that is sold for $15. The contribution margin ratio is
40%. Fixed expenses total $6,750.

Required
(a) Compute the variable cost per unit.
(b) Compute how many CDs Spears Music will have to sell in order to break even.
(c) Compute how many CDs Spears Music will have to sell in order to make a target net
income of $16,200.

Solution
(a) Variable cost per unit: $15 × (1 – .40) = $9/unit

(b) $15X – $9X – $6,750 = 0

X = 1,125 units ($6,750 ÷ $6)

(c) $15X – $9X – $6,750 = $16,200

X = 3,825 units ($22,950 ÷ $6)

PROBLEM 5
Sports Fanatic earned net income of $100,000 during 2008. The company wants to earn net
income of $40,000 more during 2009. The company's fixed costs are expected to be $84,000,
and variable costs are expected to be 30% of sales.

Instructions
(a) Determine the required sales to meet the target net income during 2009.
(b) Fill in the dollar amounts for the summary income statement for 2009 below, based on your
answer to part (a).
Sales revenue $
Variable costs
Contribution margin
Fixed costs
Net income $
Solution
(a) 70%X – $84,000 = $140,000
Required sales = $320,000 ($224,000 ÷ .70)

(b) Sales revenue $320,000

Variable costs ($320,000 ×.30) 96,000
Contribution margin 224,000
Fixed costs 84,000
Net income $140,000

PROBLEM 6
Keller Company estimates that variable costs will be 60% of sales and fixed costs will total
$1,920,000. The selling price of the product is $10, and 600,000 units will be sold.

Instructions
Using the mathematical equation,
(a) Compute the break-even point in units and dollars.
(b) Compute the margin of safety in dollars and as a ratio.
(c) Compute net income.

Solution
(a) Break-even sales in units
$10X = $6X + $1,920,000
$4X = $1,920,000
X = 480,000 units
Break-even point in dollars
X = .4X + $1,920,000
.4X = $1,920,000
X = $4,800,000

(b) Margin of safety in dollars

$6,000,000 – $4,800,000 = $1,200,000
Margin of safety ratio
$1,200,000 ÷ $6,000,000 = 20%

(c) Net Income

Sales $6,000,000
Variable Costs (3,600,000)
Fixed Costs (1,920,000)
Net Income $ 480,000

PROBLEM 7
Santa's Toys Manufacturing's sales slumped badly in 2008 due to so many people purchasing
gifts online. The company's income statement showed the following results from selling 500,000
units of product: net sales $2,125,000; total costs and expenses $2,500,000; and net loss
$375,000. Costs and expenses consisted of the following:
 Total Variable Fixed
Cost of goods sold $2,000,000 $1,300,000 $ 700,000
Selling expenses 200,000 50,000 150,000
Administrative expenses 300,000 150,000 150,000
$2,500,000 $1,500,000 $1,000,000

Management is considering the following alternative for 2009:

Purchase new automated equipment that will change the proportion between variable and
fixed expenses sold to 45% variable and 55% fixed.

Instructions
(a) Compute the break-even point in dollars for 2008.
(b) Compute the break-even point in dollars under the alternative course of action.
Solution
(a) Selling price = $2,125,000 ÷ 500,000 = $4.25 per unit
Variable cost per unit = $1,500,000  500,000 = $3 per unit
Sales – Variable cost – Fixed cost = 0
$4.25X – $3.00X – $1,000,000 = 0
Break-even point in units = 800,000 units ($1,000,000 ÷ $1.25)
Break-even point in dollars = 800,000 × $4.25 = $3,400,000

(b) New variable cost per unit = (45% × $2,500,000) ÷ 500,000 = $2.25 per unit
$4.25X – $2.25X – ($2,500,000 × 55%) = 0
New break-even point in units = 687,500 units ($1,375,000 ÷ $2)
New break-even point in dollars = 687,500 × $4.25 = $2,921,875

PROBLEM 8
Rush Company developed the following information for its product:
Per Unit
Sales price $90
Variable cost 54
Contribution margin $36

Total fixed costs $1,080,000

Instructions
Answer the following independent questions and show computations using the contribution
margin technique to support your answers.
1. How many units must be sold to break even?
2. What is the total sales that must be generated for the company to earn a profit of $60,000?
3. If the company is presently selling 45,000 units, but plans to spend an additional $108,000
on an advertising program, how many additional units must the company sell to earn the
same net income it is now making?
4. Using the original data in the problem, compute a new break-even point in units if the unit
sales price is increased 20%, unit variable cost is increased by 10%, and total fixed costs
are increased by $135,000.

Solution
1. $1,080,000
————— = 30,000 units must be sold to break even.
$36

2. Contribution margin ratio = 40% ($36 ÷ $90).

$1,080,000 + $60,000
—————————— = $2,850,000 total sales
.40

3. $108,000
———— = 3,000 additional units
$36

4. New sales price $108.00 ($90 × 1.20)

 New variable cost 59.40 ($54 × 1.10)
New contribution margin $ 48.60

New total fixed costs $1,215,000 ($1,080,000 + $135,000)

$1,215,000
————— = 25,000 units is the new break-even point.
48.60

PROBLEM 9
Sam Company makes 2 products, footballs and baseballs. Additional information follows:
Footballs Baseballs
Units 4,000 2,500
Sales $60,000 $25,000
Variable costs 36,000 7,000
Fixed costs 9,000 9,000
Net income $15,000 $ 9,000

Profit per unit $3.75 $3.60

Instructions
Sam has unlimited demand for both products. Therefore, which product should Sam tell his
sales people to emphasize?

Solution
Contribution margin per unit:
Footballs: [$60,000 – $36,000] ÷ 4,000 = $6
Baseballs: [$25,000 – $7,000] ÷ 2,500 = $7.20

Sam should tell his sales people to sell more baseballs due to the higher contribution margin per
unit.

PROBLEM 10
Unruh Company reports the following results for the month of November:
Sales (10,000 units) $600,000
Variable costs 420,000
Contribution margin 180,000
Fixed costs 110,000
Net income $ 70,000

Management is considering the following independent courses of action to increase net income.
1. Increase selling price by 6% with no change in total variable costs.
2. Reduce variable costs to 65% of sales.
3. Reduce fixed costs by $20,000.

Instructions
If maximizing net income is the objective, which is the best course of action?
Solution
1. Current selling price is: $600,000 ÷ 10,000 units = $60

Increase $60 by 6%: $60 × 1.06 = $63.60

Revised sales $636,000

Variable costs 420,000
Contribution margin 216,000
Fixed costs 110,000
Net income $106,000

Solution
2. Sales $600,000
Variable costs (reduce variable costs to 65% of sales) 390,000
Contribution margin 210,000
Fixed costs 110,000
Net income $100,000

3. Sales $600,000
Variable costs 420,000
Contribution margin 180,000
Fixed costs (reduce fixed costs by $20,000) 90,000
Net income $ 90,000

Increasing the price will increase net income from $70,000 to $106,000. Option (2) will increase
net income to only $100,000, and Option (3) will increase net income to only $90,000.

PROBLEM 11
Fenton Company had a net loss of $100,000 in 2008 when the selling price per unit was $20,
the variable costs per unit were $12, and the fixed costs were $600,000. Management expects
per unit data and total fixed costs to be the same in 2009. Management has set a goal of
earning net income of $100,000 in 2009.

Instructions
(a) Compute the units sold in 2008.
(b) Compute the number of units that would have to be sold in 2009 to reach management's
desired net income level.
(c) Assume that Fenton Company sells the same number of units in 2009 as it did in 2008.
What would the selling price have to be in order to reach the target net income? Use the
mathematical equation.

Solution
(a) Fixed costs – Net loss $600,000 – $100,000
Units sold in 2008 = ———————————— = ——————————
Contribution margin per unit $20 - $12
 = $500,000 ÷ $8 = 62,500 units

(b) Fixed costs + Net income $600,000 + $100,000

Units needed in 2009 = ————————————– = ——————————
Contribution margin per unit $20 – $12

= $700,000 ÷ $8 = 87,500 units

Solution
(c) Variable costs + Fixed costs + Net income
Selling price needed in 2008 = ———————————————————
62,500 units

62,500($12) + $600,000 + $100,000

= ————————————————
62,500 units

= $1,450,000 ÷ 62,500 = $23.20

PROBLEM 12
In the month of September, Nixon Company sold 800 units of product. The average sales price
was $30. During the month, fixed costs were $7,200 and variable costs were 60% of sales.

Instructions
(a) Determine the contribution margin in dollars, per unit, and as a ratio.
(b) Using the contribution margin technique, compute the break-even point in dollars and in
units.

Solution
(a) Contribution margin (in dollars)
Sales (800 × $30) $24,000
Less: Variable costs ($24,000 × 60%) 14,400
Contribution margin $ 9,600

Contribution margin per unit

Unit sales price $30
Less: Variable cost per unit ($30 × 60%) 18
Contribution margin per unit $12

Contribution margin ratio

$12 ÷ $30 = 40%

(b) Break-even sales (in dollars)

Fixed costs ÷ Contribution margin ratio
$7,200 ÷ 40% = $18,000

Break-even sales (in units)

Fixed costs ÷ Contribution margin per unit
$7,200 ÷ $12 = 600 units

PROBLEM 13
In 2008, Green Company had a break-even point of $800,000 based on a selling price of $10
per unit and fixed costs of $240,000. In 2009, the selling price and variable costs per unit did not
change, but the break-even point increased to $900,000.

Instructions
(a) Compute the variable cost per unit and the contribution margin ratio for 2008.
(b) Using the contribution margin ratio, compute the increase in fixed costs for 2009.

Solution
(a) Fixed Costs $240,000
Unit contribution margin = ———————————— = ————————
Break-even Sales in units ($800,000 ÷ $10)

$240,000
= ———— = $3.00
80,000

Variable cost per unit = $10 – $3 = $7

Contribution margin ratio = $3 ÷ $10 = 30%

(b) Fixed costs = Break-even Sales × CM Ratio

= $900,000 × 30% = $270,000
Therefore, fixed costs increased $30,000 ($270,000 – $240,000).

PROBLEM 14