The Shirt Works sells a large variety of tee shirts and sweatshirts. Steve Hoope

Question

The Shirt Works sells a large variety of tee shirts and sweatshirts. Steve Hooper, the owner, is thinking of expanding his sales by hiring high school students, on a commission basis, to sell sweatshirts bearing the name and mascot of the local high school. These sweatshirts would have to be ordered from the manufacturer six weeks in advance, and they could not be returned because of the unique printing required. The sweatshirts would cost Hooper $23.00 each with a minimum order of 280 sweatshirts. Any additional sweatshirts would have to be ordered in increments of 50. Since Hooper’s plan would not require any additional facilities, the only costs associated with the project would be the costs of the sweatshirts and the costs of the sales commissions. The selling price of the sweatshirts would be $46.00 each. Hooper would pay the students a commission of $8.00 for each shirt sold. 1a. To make the project worthwhile, Hooper would require a $9,750 profit for the first three months of the venture. What level of unit sales and dollar sales would be required to reach this target net operating income? 1b. Assume that the venture is undertaken and an order is placed for 280 sweatshirts. What would be Hooper’s break-even point in unit sales and in dollar sales?

Explanation / Answer

The Shirt Works

1a. determination of the number of unit sales and dollar sales needed to reach the target net operating income of $9,750:

Desired Units sales = (fixed cost + target profit)/contribution margin per unit

Contribution margin = sales – variable cost

Sales price = $46

Variable cost –

Cost of Sweatshirt = $23

Sales commission = $8

Total variable cost = $23 + $8 = $31

Contribution margin = $46 - $31 = $15

Fixed cost = 0

Hence, desired unit sales = $9,750/$15 = 650 sweatshirts

Desired dollar sales to earn target profit = $46 x 650 = $29,900

1b. Determination of break-even sales in units and break-even sales in dollars:

Break-even sales in units –

Break-even sales in units = fixed cost / contribution margin per unit

Though the fixed cost is zero, the minimum order of 280 sweatshirts cannot be returned. Hence, the cost of 280 shirts can be treated as fixed cost.

The only variable cost would the sales commission of $8 per sweatshirt.

Selling price = $46

Variable cost = $8

Contribution margin = $46 - $8 = $38

Fixed cost = $46 x 280 = $12,880

Break-even point in units = $12,880/$38 = 339 sweatshirts

Break-even point in dollar sales = $46 x 339 = $15,564

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