Chapter 4 Exercises

Step-by-Step Exercises

Question 1

Passi Company sells products for $15 per unit. Variable costs are $7 per unit, and fixed costs are $300,000. Passi sold 40,000 units this period.

Calculate before-tax profit.

Question 2

Tessera Corporation had revenues of $500,000, variable costs of $300,000, and fixed costs of $400,000. Next year, revenues are projected to increase to $1,200,000.

Calculate before-tax profit.

Question 3

MMD Corporation plans to sell 100,000 units next year for $50 each. Variable costs are $20 per unit, and fixed costs are $1,800,000.

Calculate before-tax profit.

Question 4

Grover, Inc., sells products for $100 per unit. Variable costs are $35 per unit. Fixed costs are $975,000.

Calculate the volume in units required to break even.

Question 5

Nearr Company has $200,000 in fixed costs. Variable costs are 60% of revenues.

Calculate the volume in revenues required to break even.

Question 6

Farr Company’s revenues are three times their variable costs. Fixed costs are $2,000,000.

Calculate the volume in revenues required to break even.

Question 7

Willco sells their products for $50 per unit. Variable costs are $20 per unit, and fixed costs are $450,000 per month. Willco’s target before-tax profit next month is $180,000.

Calculate the volume in units required to hit the target before-tax profit.

Question 8

Rogers Enterprises had $600,000 in revenues last year, as well as $240,000 in variable costs and $300,000 in fixed costs. Rogers hopes to increase before-tax profit by 10% next year.

Calculate the volume in revenues required to hit the target before-tax profit.

Question 9

Overnout Inc. earned $1,000,000 in profit last year, selling goods for $100 per unit and incurring variable costs of $75 per unit and fixed costs of $1,500,000. Overnout hopes to earn twice as much profit this year.

Calculate the volume in units required to hit the target before-tax profit.

Question 10

Tigreton Inc. sold 50,000 units this year. To break even, Tigreton needs to sell 30,000 units.

Calculate the margin of safety in units.

Question 11

Lionelle Company earned profit of $20,000 on revenue of $1,320,000 this year. If Lionelle had earned revenue of $1,200,000, they would have earned profit of zero.

Calculate the margin of safety in dollars.

Question 12

Berrico’s revenue this year was $350,000. To break even, Berrico needs to earn revenue of $280,000.

Calculate the margin of safety ratio.

For the following 3 questions, calculate the point of indifference between two cost structures.

Question 13

Kattico currently has revenues of $4,500,000, variable costs of $1,125,000, and fixed costs of $3,000,000. Kattico is thinking of making improvements to the production process that would increase fixed costs by $500,000 but would decrease variable costs by 40%.

At what level of revenues would Kattico be indifferent between making and not making the improvements?

Question 14

Deussin Company sells their product for $160 per unit. Variable costs are $90 per unit, and fixed costs are $77,000 per month. Deussin currently pays each of their 5 salespeople a fixed salary of $4,000 per month. Deussin is considering lowering that amount to $2,000 per month and adding a 5% sales commission for each salesperson.

At what level of unit sales would Deussin Company be indifferent between paying the current fixed salary and paying a lower fixed salary plus commissions?

Question 15

Ez-Co earns $50 per unit after covering variable costs. Fixed costs are $890,000 per year. Ez-Co is thinking of outsourcing a component of their product, which would increase variable costs by $5 per unit but would allow them to downsize production, saving $90,000 in fixed costs.

At what level of unit sales would Ez-Co Company be indifferent between outsourcing and making the component?

Complete Problems

Question 16

Combridge Company charges $500 per unit for their product, which costs $375 per unit in variable costs and $700,000 in total fixed costs.

Calculate the following:

1. Profit if Combridge sells 6,500 units
2. The number of units required to break even
3. The number of units required to earn before-tax profit of $275,000
4. The margin of safety in units if Combridge sells 6,500 units
5. The unit volume at which Combridge would be indifferent between their current cost structure and one in which fixed costs increased by $120,000 but variable costs decreased by $20 per unit

Question 17

Smithburg Corporation had revenues of $3,450,000, variable costs of $2,070,000, and fixed costs of $1,000,000 last year.

Calculate the following:

1. Profit last year
2. The revenues required to break even
3. The revenues required to earn a before-tax profit of $750,000
4. The margin of safety last year in dollars
5. The level of revenues at which Smithburg would be indifferent between their current cost structure and one in which variable costs increased by 5% and fixed costs decreased by 5%

Question 18

Puddlemuffin Corporation earned revenue of $25,000,000 last year. Variable costs were 48% of revenues and fixed costs were $7,000,000, including $1,000,000 in marketing costs.

Calculate the following:

1. Profit last year
2. The revenues required to break even
3. The revenues required to earn a before-tax profit of $5,000,000
4. The margin of safety ratio last year
5. Puddlemuffin is thinking of concentrating more on manufacturing by outsourcing their marketing to a firm that charges their clients 5% of their revenue. At what level of sales would Puddlemuffin be indifferent between their current structure and outsourcing the marketing?

Question 19

Entrepreneur Jayesh Jain is planning to start a new business. He estimates that fixed costs will be $300,000 annually for the first few years. Variable costs will be $200 per unit, and he hopes to sell each unit for $320 per unit. As this product is new, Jain is unsure of demand, but preliminary market studies show he should be able to sell 2,000 units in the first year.

Calculate the following:

1. Profit for the first year if Jain is able to sell the projected amount of units
2. Unit sales required to break even
3. Unit sales required to earn a before-tax profit of $90,000
4. The margin of safety for the first year in units
5. Suppose Jain could save $50,000 in fixed costs if he outsources part of the production process, which will cost $10 more per unit. What is the point of indifference in units?

Question 20

Finnburg Company sold 2,000,000 units last year for $0.50 each. Finnburg’s variable cost to produce a batch of 10,000 units is $750, and their fixed costs are $800,000 per year.

Calculate the following:

1. Profit last year
2. The unit sales required to break even
3. The unit sales required to earn a before-tax profit of $200,000
4. The margin of safety ratio last year
5. The level of unit sales at which Finnburg would be indifferent between their current cost structure and one in which variable costs increased by $0.10 per unit and fixed costs decreased by $180,000

Question 21

Haberdasher, Inc. sells hats that sell for $13.00 each. Haberdasher incurs $6.00 in variable costs for each hat and has annual fixed costs of $581,000. Haberdasher expects to sell 120,000 hats next year.

Haberdasher could purchase a new machine that would increase fixed costs to $595,000 per year but would decrease variable costs per unit by $0.10 per unit.

Calculate the following:

1. Haberdasher’s expected profit next year
2. Unit sales required to break even
3. Unit sales required to earn a before-tax profit of $350,000
4. The margin of safety for the first year in units
5. The point of indifference in units between buying and not buying the new machine

Assignment Problem

Note: Check figures are not provided for assignment problems so your instructor may use them for homework.

Question 22

Atmince Company sold 120,000 units this year for $15 each. Variable costs were $9 per unit, and fixed costs were $600,000.

Calculate the following:

1. Before-tax income this year
2. The number of units required to break even
3. The number of units required to earn before-tax income of $300,000
4. The margin of safety this year in units
5. The indifference point between this year’s cost structure and next year’s, when Atmince plans to raise the price by $0.75 to compensate for an expected $243,750 increase in fixed costs

Challenge Problem

Question 23

Belton Company had the following income statement last year:

Revenues	830,000
Cost of goods sold	275,000
Gross margin (GM)	555,000
Operating expenses	383,750
Before-tax income	171,250
Tax (30%)	51,375
Net income	119,875

Belton’s cost of goods sold is 80% variable. Operating expenses are 40% variable. Belton will have to lower their selling price by 20% next year to keep up with the market, but variable costs per unit are not expected to change.

Calculate the following:

1. The current revenues required to break even
2. The revenues required to break even next year
3. Projected after-tax profit next year if sales remain at the same volume as this year
4. The margin of safety ratio next year if sales remain at the same volume as this year
5. The revenues required to keep profit from declining next year

Pre-Assessment Problem

Use this problem to check whether you are fully prepared for the assessment. Work the problem under assessment conditions – don’t use any notes or other materials!

Question 24

Booknote, Inc. sells notebooks of varying sizes. Last year, Booknote earned revenue of $2,400,000 and had variable costs of $1,500,000 and fixed costs of $750,000. Next year, Booknote expects to earn $2,700,000 in revenues.

Booknote could increase production efficiency, which would increase fixed costs to $800,000 per year, and would decrease variable costs by 4%.

Calculate the following:

1. Profit next year
2. The revenues required to break even
3. The revenues required to earn a before-tax profit of $300,000
4. The margin of safety in dollars next year
5. At what level of sales would Booknote be indifferent between increasing and not increasing production efficiency?