Purpose Of Assignment: The Case Study Focus
Purpose Of Assignment The Case Study Foc
The purpose of this assignment is to analyze the effects of proposed changes on a business's contribution margin, break-even point, and margin of safety. Students will work through a scenario involving CVP (Cost-Volume-Profit) analysis, break-even analysis, and margin of safety to inform managerial decision-making.
The scenario involves Mary Willis, the advertising manager for Bargain Shoe Store, proposing a new lighting system and increased display space that will add $24,000 in fixed costs to the current $270,000. Additionally, she suggests a 5% decrease in sales price from $40 to $38, which is expected to increase sales volume by 20% (from 20,000 to 24,000 units). Variable costs are constant at $24 per pair of shoes.
Students are required to:
- Calculate the current break-even point in units and compare it to the break-even point if Mary's ideas are implemented.
- Compute the margin of safety ratio before and after the proposed changes, rounding to the nearest full percent.
- Develop CVP income statements for current operations and after implementing Mary's changes.
- Write an informal memo to management evaluating whether Mary's proposals should be adopted, supported by calculations and analysis.
Paper For Above instruction
To evaluate the proposed changes by Mary Willis at Bargain Shoe Store, a thorough CVP analysis must be undertaken to assess their impact on the company's break-even point, margin of safety, and overall profitability. This analysis provides critical insight into whether the company's strategic initiatives will enhance or hinder its financial stability.
Current Situation and Assumptions
The current fixed costs amount to $270,000, with variable costs at $24 per unit. The current selling price is $40 per unit, and the sales volume is 20,000 units. The contribution margin per unit is calculated as:
Contribution Margin per unit = Selling price - Variable costs
Therefore: $40 - $24 = $16
Current break-even point in units = Fixed costs / Contribution margin per unit
Current break-even point = $270,000 / $16 ≈ 16,875 units
Proposed Changes and Adjustments
Mary proposes adding $24,000 in fixed costs, which will raise total fixed costs to:
$270,000 + $24,000 = $294,000
She also suggests lowering the selling price to $38, leading to a new contribution margin per unit:
Contribution margin = $38 - $24 = $14
The expected increase in sales volume is 20%, from 20,000 to 24,000 units.
Assuming the sales volume is at this new level, the break-even point under the new pricing and cost structure is:
Break-even units = $294,000 / $14 ≈ 21,000 units
Comparison of Break-Even Points and Margin of Safety
Current margin of safety ratio:
Actual sales volume = 20,000 units
Break-even sales volume ≈ 16,875 units
Margin of safety in units = 20,000 - 16,875 = 3,125 units
Margin of safety ratio = (Margin of safety in units / Actual sales volume) × 100
= (3,125 / 20,000) × 100 ≈ 16%
Proposed margin of safety ratio:
Projected sales volume = 24,000 units
Break-even sales volume = 21,000 units
Margin of safety in units = 24,000 - 21,000 = 3,000 units
Margin of safety ratio = (3,000 / 24,000) × 100 ≈ 13%
CVP Income Statements
Current operations:
- Sales: 20,000 units × $40 = $800,000
- Variable costs: 20,000 units × $24 = $480,000
- Contribution margin: $800,000 - $480,000 = $320,000
- Fixed costs: $270,000
- Net operating income: $320,000 - $270,000 = $50,000
After proposed changes:
- Sales: 24,000 units × $38 = $912,000
- Variable costs: 24,000 units × $24 = $576,000
- Contribution margin: $912,000 - $576,000 = $336,000
- Fixed costs: $294,000
- Net operating income: $336,000 - $294,000 = $42,000
Analysis and Decision
The analysis indicates that while current operations yield a higher net income of $50,000, the proposed changes result in a decreased net income of $42,000, primarily due to increased fixed costs. Moreover, the break-even point increases from approximately 16,875 units to 21,000 units, which could pose a risk if sales do not meet projections.
The margin of safety ratio decreases slightly from 16% to 13%, implying a reduced cushion for unforeseen sales downturns under the new strategy. The decrease in contribution margin per unit from $16 to $14 diminishes the company's ability to absorb fixed costs effectively.
Given these financial implications, management should carefully consider whether the potential increase in sales volume justifies the higher fixed costs and lower contribution margin. The decrease in profit and margin of safety suggests that the proposed changes may not be advisable unless further benefits or efficiencies are gained.
In conclusion, based on the calculations and analysis, it appears that Mary's proposed strategy could expose the company to greater financial risk without proportionate benefits. It would be prudent to reassess the campaign's scope or explore alternative promotional strategies that do not significantly increase costs or reduce contribution margins.
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