Business Finance Chapter 5 Assignment ***Please show all computations to receive
ID: 347414 • Letter: B
Question
Business Finance
Chapter 5 Assignment
***Please show all computations to receive full credit***
Exercise 1
Carrie earned $80,000 working as a salesperson for the Now You Know advertising firm. She decided to quit this job and venture out on her own as an agent for aspiring actors and actresses. Her first year in business she did not draw a salary. The business revenues were $240,000 and total expenses were $130,000.
How much was Carrie’s accounting profit?
How much was Carrie’s entrepreneurial profit?
Exercise 2
Ken sells solar panel systems in California. His annual sales are $400,000, and net income is $30,000. He has $100,000 worth of assets invested in this business. His friend Lamar sells solar panel systems in Florida. Lamar’s annual sales are $500,000 and he earns net income of $50,000. Lamar has assets worth $250,000 invested in his business.
What is Ken’s net profit margin? What is Lamar’s net profit margin?
What is the asset turnover for Ken’s company? What is Lamar’s asset turnover?
Compare and contrast the profitability of the two solar panel firms.
Exercise 3
The Steel Shelf Company has the following operating costs:
Rent $3,000 per month
Utilities 1,100 per month
Insurance 1,500 per quarter
Property Taxes 6,000 per year
Steel $9.00 per shelf
Labor $1.00 per shelf
Sales Price $20.00 per shelf
What is the company’s variable cost per unit?
How many units per month does Steel Shelf Company need to sell to break even?
What is Steel’s contribution margin as a percentage of each dollar of sales?
If the company wants to earn a profit of $4,000 in a month, how many units do they need to sell?
If the price of steel increases by $1 for each shelf, insurance costs rise to $1,800 per quarter, and increased competition forces them to lower the sales price to $18.00 per shelf, how many units per month will Steel now need to sell to break even?
Explanation / Answer
Exercise 1
Accounting profit is a straight forward calculation of revenue – cost. Carrie’s accounting profit is $240k - $130k = $110k
Entrepreneurial profit is calculated by taking into account the opportunity cost. If Carrie had not left her job as a salesperson, she would have earned $80,000. We need to take this opportunity cost into account. Carrie’s entrepreneurial profit is $240k - $130k - $80k = $30k
Exercise 2
Profit Margin is calculated by Net Income divided by Net sales. Since the question does not have distinction between net sales and gross sales, we shall consider the mentioned value as net sales.
Ken’s profit margin is $30k / $400k = 0.075 or 7.5%
Lamar’s profit margin is $50k / $500k = 0.1 or 10%
Asset turnover is the capability of a company to generate sales from its asset. To find the value we need a ratio between the sales and asset value.
Ken’s asset turnover is $400k / $100k = 4 or 400%
Lamar’s asset turnover is $500k / $250k = 2 or 200%
To compare profitability we need compare the companies’ profit margins and asset turnover ratio. The profit margin of Lamar’s company is better than Ken’s. However, Ken’s company has a better return on assets. This means that Ken’s company is better at utilizing their assets to generate sales. Lamar’s company on the other hand relies on non-asset related skills to generate sales.
Exercise 3
Variable costs are the costs that vary with the amount of units produced. Given from the data, the variable cost per shelf is $9 + $1 = $10 per unit.
Let’s assume that X is the number of units sold that will provide the break-even. We need to split the cost between variable and fixed. The fixed cost per month are Rent ($3000), Utilities ($1100), Insurance ($1500/3) and Property tax ($6000/12). That makes the fixed cost $3000+$1100+$500+$500 = $5100 per month. The variable cost (calculated above) is $10 per unit. And the Sales price is $20. So to break even we need to equate total cost = total sales
Fixed cost + Variable cost * X = Sales price * X
5100 + 10X = 20X
5100 = 10X
510 = X
So the number of units to be sold to break even is 510.
Contribution margin is the ratio between the revenue and the difference of revenue and variable cost. For every unit, the revenue is $20. The variable cost of steel is $9. This means the different of revenue and variable cost is $20-$9 = $11. Contribution margin is $11/$20 or 55%
Let’s use the above formula again and adjust the new values. Increase variable cost by $1 and reduce sales price to $18. Also the new insurance cost is by (1800/3) = $600 or an increase of $100 per month.
Fixed cost + Variable cost * X = Sales price * X
5100 + 100 + 11X = 18X
5200 = 7X
742.85 = X or, 743
So the number of units to be sold to break even is 743.
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