Reference no: EM13922368

Problem 1:

Trace Company is a manufacturer and has the following costs from the production and sale of 480,000 CD sets for the year ended December 31, 2010. The CD sets sell for $4.50 each. The company has a 25% combined federal and state income tax rate. Trace has a plant production capacity of 600,000 CD sets.

Cost Item:
Total Cost:
Variable Manufacturing Costs:

Plastic for CD sets
$43,200
Wages for assembly workers
$600,000
Labeling
$86,400
Variable Selling Costs:

Sales commissions
$48,000
Fixed Manufacturing Costs:

Factory rent
$100,000
Factory cleaning service
$75,000
Factory machinery depreciation
$125,000
Fixed Selling & Administrative Costs:

Office equipment lease
$120,000
Systems staff salaries
$600,000
Admin management salaries
$300,000

Required:

a. Prepare an absorption (traditional) costing pre-tax income statement for Trace for the year 2010.

b. Prepare a variable (contribution margin) costing pre-tax income statement for Trace for the year 2010.

c. Compare the pre-tax income produced in ‘a' and ‘b' above. Was the pre-tax income the same or different? Explain why you obtained the results you did.

d. Would your pre-tax income answers obtained in ‘a-b-c' above change if production had been 500,000 units instead of 480,000? Why or why not? If so, by how much would it change?

e. Return to the original data. What is the unit product cost using absorption (traditional) costing?

f. Return to the original data. What is the total gross profit? The gross profit per unit? The gross profit percent?

g. What is the unit product cost using variable (contribution) costing?

h. What is the total contribution margin? The unit contribution margin? The contribution margin ratio?

i. What is the break-even point in units? In dollar sales?

j. Aren't gross profit and contribution margin the same? Why or why not?

Problem 2 - Cost-Volume-Profit Analysis (CVP),

‘What-If' Scenarios Return to the original data in Problem 1 to answer the following different scenarios being considered by Tracy's executive management. You have been brought in to head up the team analyzing the different proposals presented below.

(Consider each case independently, back to the original data in Problem 1):

a. Wages are by far the biggest cost factor of the variable manufacturing costs for the CD sets. A new labor contract is about to be signed, which will raise wages for assembly workers by 7.2%. All other costs remain unchanged.

(1) What is your new break-even point in units as a result of the increase in labor costs?
(2) What is the new per unit variable costing product cost?
(3) What is the new unit contribution margin?
(4) What is the new NOI/EBIT?

b. You have the option of leasing a new machine for $120,000 per year. By how much must your per unit assembly worker wages be reduced to pay for the lease?

c. Tracy's sales/marketing executive VP believes that a media ad campaign and a price reduction will significantly increase sales volume and profits. The ad campaign will cost $50,000 and the executive wants to reduce prices on all sales by 5%.

(1) What is the new unit contribution margin? Contribution margin ratio?
(2) What is the new break-even point in units? In sales dollars?
(3) If sales volume were to go up by 12% as a result of the ad campaign and price reduction, what would be the new NOI/EBIT?
(4) Quantitatively, would you implement this strategy compared to the original base plan in Problem 1? Why or why not?
(5) Qualitatively, what factors would you consider in this decision, above and beyond just the numbers?

d. Does the relevant range have any impact on the decision in ‘c' above? Why or why not?

There is a related concept to CVP analysis that we did not cover in class called the margin of safety. Please explain the margin of safety in words. What is the margin of safety in ‘c' above and in the base case in Problem 1? What does this tell you?