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Problem 1: complete solution correct answer key

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Problem 1: complete solution correct answer key

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?

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[Solved] Problem 1: complete solution correct answer key

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  • Submitted On 29 Jul, 2015 10:08:10
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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. Solution: Sales Revenue (480,000 x $4.50) $2,160,000 Less: Cost of goods sold $1,029,600 Gross Profit $1,130,400 Less: Selling and administrative costs $1,068,000 Pre-tax income $62,400 Cost of goods sold = Total Variable Manufacturing Costs + Fixed Manufacturing Costs = ($43,200 + $600,000 + $86,400) + ($100,000 + $75,000 + $125,000) = $1,029,600 b. Prepare a variable (contribution margin) costing pre-tax income statement for Trace for the year 2010. Solution: Sales Revenue (480,000 x $4.50) $2,160,000 Less: Variable expenses $777,600 Contribution margin $1,382,400 Less: Fixed expenses $1,320,000 Pre-tax income $62,400 Variable expenses = Total Variable Manufacturing Costs + Variable Selling Costs: = ($43,200 + $600,000 + $86,400) + $48,000 = $777,600 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. Answer: The pre-tax income statement is same under both the methods, the difference is only in the manner of presentation. 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? Solution: a) Sales Revenue (500,000 x $4.50) $2,250,000 Less: Cost of goods sold $1,029,600 Gross Profit $1,220,400 Less: Selling and administrative costs $1,068,000 Pre-tax income $152,400 Cost of goods sold = Total Variable Manufacturing Costs + Fixed Manufacturing Costs = ($43,200 + $600,000 + $86,400) + ($100,000 + $75,000 + $125,000) = $1,029,600 Selling and administrative costs = Fixed Selling and administrati...
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