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This document contains 5 analytical thinking questions and their answers related to business concepts like break-even analysis, contribution margin, and operating leverage. Specifically, it addresses:
1) Calculating operating income and its increase based on unit sales for a candle maker.
2) Identifying why a men's clothing store experienced a loss despite meeting its sales target, based on its product mix.
3) The information needed, like prices and costs, to calculate a break-even point for a new greeting card business.
4) Why two companies with the same sales may have different operating incomes and margins of safety due to variable costs and fixed costs.
5) How a chief accountant could create
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Week 2. Solutions to Analytical and critical thinking questions.docx
This document contains 5 analytical thinking questions and their answers related to business concepts like break-even analysis, contribution margin, and operating leverage. Specifically, it addresses:
1) Calculating operating income and its increase based on unit sales for a candle maker.
2) Identifying why a men's clothing store experienced a loss despite meeting its sales target, based on its product mix.
3) The information needed, like prices and costs, to calculate a break-even point for a new greeting card business.
4) Why two companies with the same sales may have different operating incomes and margins of safety due to variable costs and fixed costs.
5) How a chief accountant could create
This document contains 5 analytical thinking questions and their answers related to business concepts like break-even analysis, contribution margin, and operating leverage. Specifically, it addresses:
1) Calculating operating income and its increase based on unit sales for a candle maker.
2) Identifying why a men's clothing store experienced a loss despite meeting its sales target, based on its product mix.
3) The information needed, like prices and costs, to calculate a break-even point for a new greeting card business.
4) Why two companies with the same sales may have different operating incomes and margins of safety due to variable costs and fixed costs.
5) How a chief accountant could create
Solution to Analytical and critical thinking questions (Topic guide page2)
QUESTION 1: (CVP analysis for single product)
Lorna makes and sells decorative candles through gift shops. She knows she must sell 200 candles a month to break even. Every candle has a contribution margin of $1.50. So far this month, Lorna has sold 320 candles. How much has Lorna earned so far this month in operating income? If she sells 10 more candles, by how much will income increase?
Answer: 320 candles sold - 200 candles at breakeven = 120 candles above breakeven, Lorna has earned operating income of $180 (120 x $1.50 = $180) so far during the month. An additional 10 candles contribute $15 to operating income ($1.50 x 10).
QUESTIONS 2: (CVP analysis for multiple products)
Suppose a mens clothing store sells two brands of suits: designer suits with a contribution margin of $600 each and regular suits with a contribution margin of $500 each. At breakeven, the store must sell a total of 100 suits a month. Last month, the store sold 100 suits in total but incurred an operating loss. There was no change in fixed cost, variable cost, or price. What happened?
Answer: Probably, the sales mix shifted toward the relatively lower contribution margin suits. For example, suppose that the break-even point for regular suits was 80, and the break-even point for designer suits was 20. If the mix shifted to 90 regular and 10 designer, it is easy to see that less total contribution margin (and, hence, operating income) would be realized.
QUESTION 3: (Finding a break-even point for a new business)
You are an accountant in private practice. A friend of yours, Linda, recently started a novelty greeting card business. Linda designs greeting cards that allow the sender to write in his or her own message. She uses heavy card stock, cut to size, and decorates the front of each card with bits of fabric, lace, and ribbon in seasonal motifs (e.g., a heart for Valentines Day, a pine tree for Christmas). Linda hired several friends to make the cards, according to Lindas instructions, on a piece-work basis. (In piece work, the worker is paid on the basis of number of units produced.) The workers could make the cards at their homes, meaning that no factory facilities were involved.
Linda designs the cards and travels around her four-state region to sell the completed cards on consignment. For the few months the company has been in existence, the cards have been selling well, but Linda is operating at a loss.
What types of information do you need to find the break-even point? How can the business owner use this information to make decisions?
Answer:
In order to determine the break-even point, you need to determine the prices and variable costs for the cards. Since creating a multiproduct break-even analysis could be complex, it may be easier to determine the average price and the average variable cost for the cards, then find the total fixed cost, and tell Linda how many cards she would need to sell to break even.
Suppose that the break-even number of cards is 250 per month, and that the average contribution margin per card is $0.80. Then, as soon as Linda sells the 250th card, she knows she is in the black. From then on, every card sold adds $0.80 to her profit. This was very important information for Lindawhose business losses are coming right out of her familys checking account. Not only does Linda have a sales goal for each month, she also knows at any point in time how much income she has made.
Owners of small businesses find break-even analysis and concepts to be very helpful. A knowledge of contribution margin helps owners know how they are doing at any point in time.
2 QUESTION 4: (Operating leverage)
Two companies have identical sales revenue of $15 million. Is it true that both have the same operating income and the same margin of safety? Is it possible that one company has a higher margin of safety?
Answer: It is not necessarily true that the two companies make the same operating income. If one company has lower variable costs per unit and/or a lower total fixed cost, then its operating income would be higher. The differences in variable cost per unit and total fixed cost would lead to different break- even revenues. Of course, the company with the lower break-even sales would have a higher margin of safety.
QUESTION 5: (Using Contribution Margin Income Statements to Consider Varying Scenarios)
You are the chief accountant for Boyne winter sports. Early in the year, you had budgeted sales prices (lift tickets, restaurant prices), costs, and expected quantity to be sold. However, once the season starts, you will know from week to week more about the actual weather conditions.
How can you use this information about current weather conditions to better predict budgets for Boyne?
Answer: You can recast the budgeted statements according to how the weather will affect skiing. If the snow is good, some costs will go down.
For example, you will lower the predicted cost of running the snow-making machines. However, good weather and more skiers will require additional seasonal hiring as more direct labor will be needed to run the lifts, operate ski equipment rental shops, restaurants, and so on. You can put together contribution margin income statements under various scenarios, increasing volume with good ski weather, decreasing it with poor weather.
Having the ability to recast budgets will help managers respond quickly to the changing conditions and be able to raise or lower some prices as needed.