Fredonia Inc. had a bad year in 2013. For the first time in its history, it oper

Question

Fredonia Inc. had a bad year in 2013. For the first time in its history, it operated at a loss. The company's income statement showed the following results from selling 79,100 units of product: Net sales $1,542,450; total costs and expenses $1,751,500; and net loss $209,050. Costs and expenses consisted of the following. Management is considering the following independent alternatives for 2014. Increase unit selling price 22% with no change in costs and expenses. Change the compensation of salespersons from fixed annual salaries totaling $203,500 to total salaries of $40,900 plus a 5% commission on net sales. Purchase new high-tech factory machinery that will change the proportion between variable and fixed cost of goods sold to 50:50. Compute the break-even point in dollars for 2014. (Round contribution margin ratio to 4 decimal places e.g. 0.2512 and final answers to O decimal places, e.g. 2,510.) Compute the break-even point in dollars under each of the alternative courses of action. (Round contribution margin ratio to 4 decimal places e.g. 0.2512 and final answers to O decimal places, e.g. 2,510.)

Explanation / Answer

Solution:

Calculation of Break Even Point in dollars for 2014

Total Contribution Margin = Sales – Variable Cost = $1,542,450 - $909,200 = $633,250

Contribution Margin Ratio = Contribution Margin / Sales x 100 = $633,250 / $1,542,450 x 100 = 41.0548%

Fixed Cost = $842,300

Break Even Point in dollars for 2014 = Fixed Cost / Contribution Margin Ratio = $842,300 / 0.410548 = $2,051,648

Calculation of Break Even Point in dollars under each of the alternative course of action

Alternative 1

(Increase Selling Price)

Alternative 2

(Change Compensation)

Alternative 3

(Purchase Machinery)

Net Sales

$1,881,789

$1,542,450.00

$1,542,450

Total Variable Cost (Note 1)

$909,200

$986,322.50

$731,500

Contribution Margin

(Sales - Total Variable Cost)

$972,589

$556,127.50

$810,950

Contribution Margin Ratio

(Contribution / Sales x 100)

51.6843%

36.0548%

52.5754%

Total Fixed Cost (note 2)

$842,300

$679,700

$1,020,000

Break Even Point in dollars

(Fixed Cost / Contribution margin ratio)

$1,629,702

$1,885,186

$1,940,071

Note 1—Total Variable Cost under each alternative

Alternative 1 (Increase Selling Price) = Same as old Variable Cost = $909,200

Alternative 2 (Change Compensation) = Old Variable Cost + 5% Commission on Sales = $909,200 + ($1,542,450 x 5%) = $986,322.50

Alternative 3 (Purchase Machinery) = 50% of Total COGS + Variable Selling Expenses + Variable Administrative Expenses

= ($1,204,600 x 50%) + $75,500 + $53,700 = $602,300 + $75,500 + $53,700 = $731,500

Note 2 – Total Fixed Cost under each alternative

Alternative 1 (Increase Selling Price) = same as old = $842,300

Alternative 2 (Change Compensation) = $842,300 - $203,500 + $40,900 = $679,700

Alternative 3 (Purchase Machinery) = 50% of Total COGS + Fixed Selling Expenses + Fixed Administrative Expenses

= ($1,204,600 x 50%) + $340,500 + $77,200 = $602,300 + $340,500 + $77,200 = $1,020,000

Recommendation

Alternative 1 (Increase in Selling Price) should be recommended, since the break-even point in dollars are minimum in this course of action.

Alternative 1

(Increase Selling Price)

Alternative 2

(Change Compensation)

Alternative 3

(Purchase Machinery)

Net Sales

$1,881,789

$1,542,450.00

$1,542,450

Total Variable Cost (Note 1)

$909,200

$986,322.50

$731,500

Contribution Margin

(Sales - Total Variable Cost)

$972,589

$556,127.50

$810,950

Contribution Margin Ratio

(Contribution / Sales x 100)

51.6843%

36.0548%

52.5754%

Total Fixed Cost (note 2)

$842,300

$679,700

$1,020,000

Break Even Point in dollars

(Fixed Cost / Contribution margin ratio)

$1,629,702

$1,885,186

$1,940,071

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