EXERCISE 6-17 (30 MINUTES)

4. No information is given in the problem concerning the new variable ex-

penses or the new contribution margin ratio. Both of these items must

be determined before the new break-even point can be computed. The

computations are:

New variable expenses:

Sales = Variable expenses + Fixed expenses + Profits

$585,000*= Variable expenses + $180,000 + $54,000**

$351,000 = Variable expenses

*New level of sales: $450,000 × 1.30 = $585,000

**New level of net operating income: $45,000 × 1.2 = $54,000

New CM ratio:

Sales ... $585,000 100%

Less variable expenses... 351,000 60

Contribution margin... $234,000 40%

With the above data, the new break-even point can be computed:

Fixed expenses $180,000

Break-even point= in dollar sales CM ratio = 0.4 =$450,000

Problem 6-28 (continued)

The greatest risk is that the marketing manager’s estimates of increases

in sales and net operating income will not materialize and that sales will

remain at their present level. Note that the present level of sales is

$450,000, which is just equal to the break-even level of sales under the

new marketing method. Thus, if the new marketing strategy is adopted

and sales remain unchanged, profits will drop from the current level of

$45,000 per month to zero.

It would be a good idea to compare the new marketing strategy to the

current situation more directly. What level of sales would be needed un-

der the new method to generate at least the $45,000 in profits the

company is currently earning each month? The computations are:

Fixed expenses + Target profit

Dollar sales to attain= target profit CM ratio

$180,000 + $45,000

= 0.40

= $562,500 in sales each month

Thus, sales would have to increase by at least 25% ($562,500 is 25%

higher than $450,000) in order to make the company better off with the

new marketing strategy than with the current situation. This appears to

be extremely risky.

Problem 6-29 (45 minutes)