EXERCISE 6-17 (30 MINUTES)

3. The reason for the increase in the break-even point can be traced to the

decrease in the company’s overall contribution margin ratio when the

third product is added. Note from the income statements above that this

ratio drops from 65% to 48.8% with the addition of the third product.

This product (the Samoan Delight) has a CM ratio of only 20%, which

causes the average contribution margin per dollar of sales to shift

downward.

This problem shows the somewhat tenuous nature of break-even analy-

sis when the company has more than one product. The analyst must be

very careful of his or her assumptions regarding sales mix, including the

addition (or deletion) of new products.

It should be pointed out to the president that even though the break-

even point is higher with the addition of the third product, the com-

pany’s margin of safety is also greater. Notice that the margin of safety

increases from $68,000 to $275,000 or from 8.5% to 22%. Thus, the

addition of the new product shifts the company much further from its

break-even point, even though the break-even point is higher.

Problem 6-30 (60 minutes)