SOLUTION CH.

Exercise 5-18 (30 minutes)

1. Profit = Unit CM × Q − Fixed expenses

$0 = ($30 − $12) × Q − $216,000
$0 = ($18) × Q − $216,000
$18Q = $216,000
Q = $216,000 ÷ $18
Q = 12,000 units, or at $30 per unit, $360,000

Alternative solution:
Unit sales = Fixed expenses
to break even Unit contribution margin

$216,000
= = 12,000 units
$18
or at $30 per unit, $360,000

2. The contribution margin is $216,000 because the contribution margin is

equal to the fixed expenses at the break-even point.

3. The unit sales to attain the target profit is computed as follows:

Units sold to attain = Target profit + Fixed expenses

target profit Unit contribution margin
$90,000 + $216,000
=
$18
= 17,000 units

Total Unit
Sales (17,000 units × $30 per unit) ....... $510,000 $30
Variable expenses
(17,000 units × $12 per unit) ............. 204,000 12
Contribution margin.............................. 306,000 $18
Fixed expenses .................................... 216,000
Net operating income ........................... $ 90,000
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 SOLUTION CH. 6

Exercise 5-18 (continued)

4. Margin of safety in dollar terms:
Margin of safety = Total sales - Break-even sales
in dollars

= $450,000 - $360,000 = $90,000

Margin of safety in percentage terms:
Margin of safety = Margin of safety in dollars
percentage Total sales
$90,000
= = 20%
$450,000

5. The CM ratio is 60% [= ($30 – $12) ÷ $30].

Expected total contribution margin: ($500,000 × 60%) .. $300,000

Present total contribution margin: ($450,000 × 60%)..... 270,000
Increased contribution margin ....................................... $ 30,000

Alternative solution:
$50,000 incremental sales × 60% CM ratio = $30,000

Given that the company’s fixed expenses will not change, monthly net
operating income will also increase by $30,000.
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 SOLUTION CH. 6

Problem 5-20 (75 minutes)

1. a. Selling price ..................... $25 100%

Variable expenses ............ 15 60%
Contribution margin ......... $10 40%
Profit = Unit CM × Q − Fixed expenses
$0 = $10 × Q − $210,000
$10Q = $210,000
Q= $210,000 ÷ $10
Q= 21,000 balls
Alternative solution:
Unit sales to = Fixed expenses
break even Unit contribution margin

$210,000
=
$10
= 21,000 balls
b. The degree of operating leverage is:
Degree of Contribution margin
=
operating leverage Net operating income

$300,000
= = 3.33 (rounded)
$90,000

2. The new CM ratio will be:

Selling price .................... $25 100%
Variable expenses............ 18 72%
Contribution margin ......... $ 7 28%
The new break-even point will be:
Profit = Unit CM × Q − Fixed expenses
$0 = $7 × Q − $210,000
$7Q = $210,000
Q= $210,000 ÷ $7
Q= 30,000 balls
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 SOLUTION CH. 6

Problem 5-20 (continued)

Alternative solution:
Unit sales to = Fixed expenses
break even Unit contribution margin
$210,000
=
$7
= 30,000 balls

3. Profit = Unit CM × Q − Fixed expenses

$90,000 = $7 × Q − $210,000
$7Q = $90,000 + $210,000
Q= $300,000 ÷ $7
Q= 42,857 balls (rounded)
Alternative solution:
Unit sales to attain = Target profit + Fixed expenses
target profit Unit contribution margin
$90,000 + $210,000
= = 42,857 balls
$7
Thus, sales will have to increase by 12,857 balls (= 42,857 balls –
30,000 balls = 12,857 balls) to earn the same amount of net operating
income as last year. The computations above and in part (2) show the
dramatic effect that increases in variable costs can have on an
organization. The effects on Northwood Company are summarized
below:
Present Expected
Break-even point (in balls) ................................. 21,000 30,000
Sales (in balls) needed to earn a $90,000 profit .. 30,000 42,857
Note that if variable costs do increase next year, then the company will
just break even if it sells the same number of balls (30,000) as it did last
year.
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 SOLUTION CH. 6

Problem 5-20 (continued)

4. The contribution margin ratio last year was 40%. If we let P equal the
new selling price, then:
P = $18 + 0.40P
0.60P = $18
P = $18 ÷ 0.60
P = $30
To verify:
Selling price .................... $30 100%
Variable expenses ........... 18 60%
Contribution margin ........ $12 40%
Therefore, to maintain a 40% CM ratio, a $3 increase in variable costs
would require a $5 increase in the selling price.

5. The new CM ratio would be:

Selling price ........................ $25 100%
Variable expenses ................ 9* 36%
Contribution margin ............. $16 64%
*$15 – ($15 × 40%) = $9
The new break-even point would be:
Profit = Unit CM × Q − Fixed expenses
$0 = $16 × Q – ($210,000 × 2)
$16Q = $420,000
Q= $420,000 ÷ $16
Q= 26,250 balls
Alternative solution:
Unit sales to = Fixed expenses
break even Unit contribution margin

$420,000
= = 26,250 balls
$16
Although this new break-even point is greater than the company’s
present break-even point of 21,000 balls [see Part (1) above], it is less
than the break-even point will be if the company does not automate and
5

variable labor costs rise next year [see Part (2) above].
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 SOLUTION CH. 6

Problem 5-20 (continued)

6. a. Profit = Unit CM × Q − Fixed expenses

$90,000 = $16 × Q − $420,000
$16Q = $90,000 + $420,000
Q = $510,000 ÷ $16
Q = 31,875 balls
Alternative solution:
Unit sales to attain = Target profit + Fixed expenses
target profit Unit contribution margin

= $90,000 + $420,000
$16
= 31,875 balls
Thus, the company will have to sell 1,875 more balls (31,875 –
30,000 = 1,875) than now being sold to earn a profit of $90,000 per
year. However, this is still less than the 42,857 balls that would have
to be sold to earn a $90,000 profit if the plant is not automated and
variable labor costs rise next year [see Part (3) above].

b. The contribution income statement would be:

Sales (30,000 balls × $25 per ball) .................... $750,000
Variable expenses (30,000 balls × $9 per ball) ... 270,000
Contribution margin .......................................... 480,000
Fixed expenses ................................................. 420,000
Net operating income........................................ $ 60,000

Degree of Contribution margin

=
operating leverage Net operating income

$480,000
= =8
$60,000
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 SOLUTION CH. 6

Problem 5-20 (continued)

c. This problem illustrates the difficulty faced by some companies. When
variable labor costs increase, it is often difficult to pass these cost
increases along to customers in the form of higher prices. Thus,
companies are forced to automate resulting in higher operating
leverage, often a higher break-even point, and greater risk for the
company.
There is no clear answer as to whether one should have been in favor
of constructing the new plant.
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 SOLUTION CH. 6

Problem 5-23 (60 minutes)

1. The CM ratio is 60%:

Sales price ...................... $20.00 100%

Variable expenses ........... 8.00 40%
Contribution margin......... $12.00 60%

2. Dollar sales to Fixed expenses

=
break even CM ratio
$180,000
=
0.60
= $300,000

3. $75,000 increased sales × 0.60 CM ratio = $45,000 increased

contribution margin. Because the fixed costs will not change, net
operating income should also increase by $45,000.

4a. The degree of operating leverage is calculated as follows:

Degree of Contribution margin

=
operating leverage Net operating income

$240,000
=
$60,000
=4
4b. 4 × 20% = 80% increase in net operating income. In dollars, this
increase would be 80% × $60,000 = $48,000.
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 SOLUTION CH. 6

Problem 5-23 (continued)

5. This year’s net operating income is computed as follows:

Sales (25,000 units × $18 per unit) .................... $450,000

Variable expenses (25,000 units × $8 per unit) ... 200,000
Contribution margin ........................................... 250,000
Fixed expenses ($180,000 + $30,000) ................ 210,000
Net operating income ........................................ $ 40,000

The sales manager’s suggestions should not be implemented because

they will lower net operating income by $20,000 (= $60,000 – $40,000).

6. Expected total contribution margin:

20,000 units × 1.25 × $11.00 per unit* ........................ $275,000
Present total contribution margin .................................... 240,000
Incremental contribution margin, and the amount by
which advertising can be increased with net operating
income remaining unchanged ....................................... $ 35,000
*$20.00 – ($8.00 + $1.00) = $11.00
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 SOLUTION CH. 6

Problem 5-30 (60 minutes)

1. Profit = Unit CM × Q − Fixed expenses

$0 = ($40 − $16) × Q − $60,000
$0 = ($24) × Q − $60,000
$24Q = $60,000
Q = $60,000 ÷ $24
Q = 2,500 pairs, or at $40 per pair, $100,000 in sales
Alternative solution:
Unit sales to = Fixed expenses = $60,000 = 2,500 pairs
break even CM per unit $24.00
Dollar sales to = Fixed expenses = $60,000 = $100,000
break even CM ratio 0.60
2. See the graphs at the end of this solution.

3. Profit = Unit CM × Q − Fixed expenses

$18,000 = $24 × Q − $60,000
$24Q = $18,000 + $60,000
Q = $78,000 ÷ $24
Q = 3,250 pairs
Alternative solution:
Unit sales to attain = Target profit + Fixed expenses
target profit Unit contribution margin

$18,000 + $60,000
= = 3,250 pairs
$24.00

4. Incremental contribution margin:

$25,000 increased sales × 60% CM ratio ..... $15,000
Incremental fixed salary cost ......................... 8,000
Increased net income .................................... $ 7,000
Yes, the position should be converted to a full-time basis.
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 SOLUTION CH. 6

Problem 5-30 (continued)

5. a. Degree of Contribution margin $72,000
= = =6
operating leverage Net operating income $12,000

b. 6 × 50% sales increase = 300% increase in net operating income.

Thus, net operating income next year would be: $12,000 + ($12,000
× 300%) = $48,000.

2. Cost-volume-profit graph:

$200

Total Sales
$180

$160

$140 Break-even point:

Total
Total Sales (000s)

2,500 pairs of sandals or

Expense
$120 $100,000 total sales
s
$100

$80
Total
$60 Fixed
Expense
$40 s

$20

$0
0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500 5,000
Number of Pairs of Sandals Sold
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SOLUTION CH. 6