Andre Has Asked You To Evaluate His Business: Andres Hair St
Andre Has Asked You To Evaluate His Business Andres Hair Styling An
Andre has asked you to evaluate his business, Andre’s Hair Styling. Andre has five barbers working for him. (Andre is not one of them.) Each barber is paid $9.90 per hour and works a 40-hour week and a 50-week year, regardless of the number of haircuts. Rent and other fixed expenses are $1,750 per month. Hair shampoo used on all clients is $0.40 per client. Assume that the only service performed is the giving of haircuts (including shampoo), the unit price of which is $12.
Andre has asked you to find the following information:
1. Find the contribution margin per haircut. Assume that the barbers' compensation is a fixed cost. Show calculations to support your answer.
2. Determine the annual break-even point, in number of haircuts.
3. Support your answer with an appropriate explanation. Show calculations to support your answer.
4. What will be the operating income if 20,000 haircuts are performed? Show calculations to support your answer.
5. Suppose Andre revises the compensation method: The barbers will receive $4 per hour plus $6 for each haircut. What is the new contribution margin per haircut? What is the annual break-even point (in number of haircuts)? Show calculations to support your answer.
Paper For Above instruction
Introduction
The financial analysis of Andre's Hair Styling provides critical insights into its profitability and operational efficiency. By understanding contribution margins, break-even points, and the impact of compensation structure changes, Andre can make informed decisions to optimize business performance. This paper calculates the contribution margin per haircut, determines the annual break-even point, projects operating income at a specified haircut volume, and explores the effects of a new barber compensation plan.
Contribution Margin Per Haircut
The contribution margin (CM) per unit is the selling price minus variable costs. For Andre's Hair Styling, the selling price per haircut is $12. The variable costs include the shampoo per client, which is $0.40, and the barber's compensation, which is fixed in this part of the analysis, thus not considered in the CM calculation.
Calculation:
\[
\text{Contribution Margin per haircut} = \text{Selling price} - \text{Variable costs}
\]
\[
\text{CM} = \$12 - \$0.40 = \$11.60
\]
Since barber compensation is fixed and does not vary with the number of haircuts, it is not deducted here when calculating the contribution margin. Therefore, the contribution margin per haircut is $11.60.
Annual Break-Even Point Calculation
The break-even point occurs when total contribution margin equals total fixed costs. Fixed costs include the monthly rent and fixed barber wages.
Calculations:
- Fixed monthly expenses:
\[
\$1,750
\]
- Fixed annual expenses:
\[
\$1,750 \times 12 = \$21,000
\]
- Total fixed costs (barber wages are fixed and considered in gross profit but do not affect contribution margin in this calculation).
Given the contribution margin per haircut ($11.60), the break-even volume (number of haircuts) is:
\[
\text{Break-even haircuts} = \frac{\text{Total fixed costs}}{\text{Contribution margin per haircut}}
\]
\[
= \frac{\$21,000}{\$11.60} \approx 1810.34
\]
Rounding up, 1,811 haircuts are needed annually to break even.
Explanation:
Since barber wages are paid regardless of the number of haircuts, they are classified as fixed costs and do not influence the contribution margin directly. The break-even point indicates the number of haircuts required to cover fixed expenses, with any additional haircuts contributing profit.
Projected Operating Income at 20,000 Haircuts
To compute operating income:
- Total revenue:
\[
20,000 \times \$12 = \$240,000
\]
- Total variable costs:
- Shampoo:
\[
20,000 \times \$0.40 = \$8,000
\]
- Barber wages:
Since pay is fixed at $9.90/hour, total wages per barber:
\[
\$9.90 \times 40 \text{ hours/week} \times 50 \text{ weeks} = \$19,800
\]
Total wages for all five barbers:
\[
\$19,800 \times 5 = \$99,000
\]
- Since wages are fixed, they are not deducted in contribution margin calculations but are used to determine net operating income.
- Fixed expenses (rent):
\[
\$1,750 \times 12 = \$21,000
\]
Total fixed costs:
\[
\$99,000 + \$21,000 = \$120,000
\]
But for operating income:
\[
\text{Total revenue} - \text{Variable costs} - \text{Fixed costs}
\]
Calculations:
\[
\$240,000 - \$8,000 - \$120,000 = \$112,000
\]
Result:
The operating income at 20,000 haircuts is $112,000.
Impact of Revised Compensation Method
The new pay structure:
- $4 per hour plus $6 per haircut.
Calculations:
- Wages per barber:
\[
(\$4 \times 40 \text{ hours}) + (\$6 \times \text{number of haircuts})
\]
The contribution margin per haircut under new compensation:
- Selling price remains $12.
- Variable costs:
- Shampoo: $0.40
- Barber wages per haircut:
Given the split, the wage per haircut is $6, and the hourly wage component depends on total hours worked. But because wages are now based both on hours and haircuts, the per haircut wage component is:
Total wages per barber:
\[
(\$4 \times 40) + (\$6 \times \text{total number of haircuts}) / \text{number of haircuts}
\]
However, to simplify the calculation for contribution margin, note that:
- Wages per haircut are now $6.
- Variable costs remain $0.40 (shampoo).
Therefore, the new contribution margin per haircut:
\[
\$12 - \$0.40 - \$6 = \$5.60
\]
Now, to find the new break-even point:
\[
\text{Fixed costs} = \text{Total wages} + rent
\]
- Total wages: sum of fixed wage part and per haircut wage:
\[
\text{Total wages} = (\$4 \times 40 \text{ hours } \times 5 \text{ barbers} \times 50 \text{ weeks}) + (\$6 \times \text{total haircuts})
\]
Total fixed wages:
\[
\$4 \times 40 \times 5 \times 50 = \$40,000
\]
- Wages per haircut:
\[
\$6 \times \text{number of haircuts}
\]
Total wages including per haircut payment:
\[
\$40,000 + \$6 \times \text{number of haircuts}
\]
But for the break-even calculation, fixed costs include the fixed wage component (\$40,000) plus rent:
\[
\$21,000 \text{ (rent)} + \$40,000 \text{ (fixed wage)} = \$61,000
\]
Break-even point:
\[
\text{Number of haircuts} = \frac{\text{Total fixed costs}}{\text{Contribution margin per haircut}}
\]
\[
= \frac{\$61,000}{\$5.60} \approx 10,911
\]
Summary:
- New contribution margin per haircut: $5.60.
- New annual break-even volume: approximately 10,911 haircuts.
Conclusion
The analysis demonstrates that when barber compensation is fixed, the contribution margin per haircut is high, and the business requires fewer haircuts to break even. Transitioning to a variable pay plan decreases the contribution margin but aligns costs more closely with revenue, significantly increasing the break-even volume. For optimal profitability, Andre must consider how the compensation structure influences operating leverage, variable versus fixed costs, and overall business sustainability. The operation's profitability at higher haircut volumes remains strong, but the new compensation model substantially raises the threshold to break even, requiring careful evaluation.
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