Purpose Of Assignment: The Case Study Focuses On CVP 885231

Purpose Of Assignmentthe Case Study Focuses On Cvp Cost Volume Profit

The case study focuses on CVP (Cost-Volume-Profit), break-even analysis, and margin of safety assessments to help students analyze how managerial decisions impact business profitability. The scenario involves Mary Willis, the advertising manager of Bargain Shoe Store, proposing changes to enhance promotional efforts, including increased fixed costs and a price reduction aimed at boosting sales volume. The assignment requires calculating the current and projected break-even points, determining the margin of safety ratios before and after the proposed changes, and preparing CVP income statements for both scenarios. Additionally, students must compose an informal memo to management that evaluates whether or not to adopt Mary's suggestions, supported by calculations and analysis.

Paper For Above instruction

The Bargain Shoe Store, under the management of Mary Willis, faces a critical decision regarding a proposed promotional campaign aimed at increasing sales volume through strategic price reductions and enhanced display features. This case study embodies core managerial accounting principles, particularly the application of Cost-Volume-Profit (CVP) analysis, break-even point calculations, and margin of safety assessments. By examining these financial metrics, management can make informed decisions regarding the impact of proposed changes on profitability and operational stability.

Current Financial and Operational Overview

Currently, Bargain Shoe Store incurs fixed costs of $270,000, with variable costs of $24 per pair of shoes. The store sells shoes at an original price point of $40 per pair, with an annual sales volume of 20,000 units. The selling price and cost structure serve as the foundation for calculating the existing break-even point, which signifies the sales volume at which revenues equate total costs, resulting in zero profit.

To compute the current break-even point in units, the formula is:

Break-even units = Fixed costs / (Selling price per unit – Variable cost per unit)

Applying the current figures:

Break-even units = $270,000 / ($40 – $24) = $270,000 / $16 = 16,875 units

This indicates that the store must sell approximately 16,875 pairs of shoes annually to cover all fixed and variable costs, thus breaking even.

Proposed Changes and Their Financial Impact

Mary’s proposal introduces an additional $24,000 fixed cost due to new lighting and display enhancements, raising total fixed costs to $294,000. She also suggests a 5% reduction in selling price, decreasing it from $40 to $38 per pair, coupled with a projected 20% increase in sales volume, from 20,000 to 24,000 units.

To evaluate these changes, the new variables include:

  • New selling price: $38
  • Variable cost: $24 (unchanged)
  • New fixed costs: $294,000
  • Projected sales volume: 24,000 units

The new break-even point is calculated as:

Break-even units = $294,000 / ($38 – $24) = $294,000 / $14 ≈ 21,000 units

Comparing the current and projected break-even points reveals an increase from 16,875 to approximately 21,000 units, indicating a higher sales volume requirement for profitability after the proposed changes.

Margin of Safety Ratios

The margin of safety ratio indicates how much sales can decline before the business reaches its break-even point, expressed as a percentage of actual sales. Calculations for current and proposed scenarios are as follows:

Current margin of safety ratio:

(Actual sales – Break-even sales) / Actual sales = (20,000 – 16,875) / 20,000 = 3,125 / 20,000 = 0.15625 or approximately 16%

Projected margin of safety ratio after changes:

(Projected sales – New break-even sales) / Projected sales = (24,000 – 21,000) / 24,000 = 3,000 / 24,000 = 0.125 or 13%

These calculations suggest a decrease in the safety margin, implying increased risk, as sales would need to stay closer to the break-even point to avoid losses.

CVP Income Statements Analysis

The CVP income statement provides a snapshot of projected profitability under both scenarios. For the current operations:

  • Sales Revenue: 20,000 units x $40 = $800,000
  • Variable Costs: 20,000 units x $24 = $480,000
  • Contribution Margin: $800,000 – $480,000 = $320,000
  • Fixed Costs: $270,000
  • Net Operating Income: $320,000 – $270,000 = $50,000

For the projected scenario with proposed changes:

  • Sales Revenue: 24,000 units x $38 = $912,000
  • Variable Costs: 24,000 units x $24 = $576,000
  • Contribution Margin: $912,000 – $576,000 = $336,000
  • Fixed Costs: $294,000
  • Net Operating Income: $336,000 – $294,000 = $42,000

The analysis reveals that despite higher sales volume and contribution margins, the net operating income decreases slightly post-implementation, mainly due to higher fixed costs and a lower selling price, reducing overall profitability margins.

Managerial Decision-Making and Recommendations

In evaluating whether to accept Mary Willis’s proposed changes, it is critical to consider both the quantitative financial impacts and qualitative considerations such as market competitiveness and long-term strategic positioning. The decrease in the margin of safety from 16% to 13% indicates amplified risk, as any unforeseen decline in sales could push the business into losses.

Moreover, the increased fixed costs and lower contribution margin per unit reduce overall profitability, despite the increased sales volume. The slight dip in net operating income (from $50,000 to $42,000) illustrates that the proposed promotional enhancements may not generate a significant profit increase and might heighten financial risk.

Conversely, these strategies could hold long-term benefits, such as increased market share, customer engagement, and competitive positioning. Such non-financial benefits should be considered alongside the CVP analysis. If the store can sustain the higher fixed costs and achieve the projected sales volume, the changes could be justified. However, if market conditions deteriorate or sales do not meet projections, the increased risk could adversely affect the store’s profitability.

In conclusion, based solely on the quantitative analysis, the proposed changes appear to introduce additional risk without a commensurate increase in profitability. Therefore, management should consider cautious implementation, perhaps testing the strategies incrementally or conducting further market research to validate assumptions. It would also be prudent to develop contingency plans to mitigate risks associated with decreased safety margins and higher fixed costs.

References

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