Problem 1 -
Cavalier Chairs, Inc., a producer and retailer of custom design office chairs, is considering opening a new retail store.
In negotiating the cost of the space, they were given two rental options:
- Option 1 - A fixed rental price of $1,200 per week; OR
- Option 2 - A rental charge based on total sales. The charge would be 15% of monthly sales revenue plus a fixed monthly payment of $1,000.
For the new retail store, Cavalier Elements estimates that their other costs would be:
- Average cost of store items = $175 per unit
- Store manager's salary = $850 per month
- Sales commissions = 10% of sales revenue
- Other selling, general and administrative expenses = 8% of sales plus a monthly cost of $1,000 per month, (i.e. this amount does not include store rental costs or store manager's salary).
The average selling price of a Cavalier's office chair is $375 each.
Required -
a. Assuming the initial month's expected unit sales are 50 chairs, prepare a Contribution Margin Income Statement for Option 1 and a Contribution Margin Income Statement for Option 2,
b. Compute the breakeven in sales units for (a) Option 1 and (b) Option 2.
c. Determine the level of total revenues at which the company will be indifferent between Option 1 and Option 2.
d. Compute the degree of operating leverage at sales of 50 units for (a) Option 1 and (b) Option 2.
e. Given your computation in d., which Option will have the greater increase in income with increases in sales activity? Please explain your answer.
f. Given your computation in d., which Option is the least risky Option if the demand for Cavalier's chairs declines in subsequent period? Please explain your answer.
Problem 2 -
In preparation for arranging a $300,000 bank line of credit, Terra, Inc. needs to prepare a detailed budget.
Their budget director has completed parts of the budget. For example, he has provided the following budgeted sales for the selected four-month period:
|
Month
|
Unit Sales
|
|
April
|
100,000
|
|
May
|
155,000
|
|
June
|
115,000
|
|
July
|
130,000
|
At the beginning of April, the company had 40,000 units of finished goods in inventory.
Their budget guidance indicates that they should retain their levels of finished goods inventory equal to 20 percent of the unit sales for the next month.
In addition, in their production process:
- They use 5 pounds of a single raw material for each unit produced. Each pound of material costs $8.
- Plans are to have inventory levels for materials equal to 25% percent of the amount of materials needed to satisfy next month's production and 175,000 units of raw material on hand at the end of June.
- Materials inventory on April 1 was 118,000 pounds.
Required: Using the given information, prepare the following:
a. A Production budget in units for April, May, and June.
b. A Materials Purchases budget in pounds and in dollars for April, May, and June.
Additionally, answer the following questions:
c. Explain the term/concept of budgetary slack. Why does it occur? What is the primary indication that budgetary slack is occurring?
d. Management experts argue that motivational considerations should be a part of budget planning and utilization. What do you believe is their reason for such an observation? Do you agree? Please explain your answer.
e. Lastly, please list 4 steps a manager might take to motivate employees to participate effectively in the budgeting process.
Problem 3 -
Comfort & Ease, Inc. produces and sells mattresses. The mattresses are available in the traditional sizes - Double, Queen, and King.
Frank Burns, the company Controller, prepared a Brand Profit Report detailing the profitability of the 3 brands:
|
Double
|
Queen
|
King
|
Total
|
|
# units sold
|
20,000
|
30,000
|
50,000
|
100,000
|
|
|
|
|
|
|
Sales
|
$200,000
|
$450,000
|
$1,000,000
|
$1,650,000
|
|
Less: Variable costs
|
(100,000)
|
(270,000)
|
(600,000)
|
(970,000)
|
|
Less: Fixed costs
|
(110,000)
|
(165,000)
|
(275,000)
|
(550,000)
|
|
Income/ (Loss)
|
$ (10,000)
|
$ 15,000
|
$ 125,000
|
$ 130,000
|
In the Brand Profit Report, variable costs represent the direct costs associated with producing the mattresses (e.g. materials and labor, etc.) and fixed costs represent common costs shared by all the products (e.g. depreciation, insurance, supervisor salaries, etc.). Common costs are allocated based on #units produced and sold (assume the company sells all that it produces).
When Caroline Ease, the company's President, reviewed the analysis, she asked Mr. Burns what the effect on Operating Income would be, if the company discontinued producing and selling the "Double" mattress size.
Required -
a. Revise the Brand Profit Report assuming the "Double" mattress brand is discontinued.
b. After revising the Brand Profit Report in part a. above, if either the Queen or King brand shows an Operating Loss, further revise the Brand Profit Report to show the implications of discontinuing that item.
c. Write a brief note explaining your observations regarding discontinuing unprofitable brands when common costs are part of the profit analysis, including a recommendation of whether to proceed with that option.
d. Ignoring the results from parts a., b., & c. above, revise the original Brand Profit Report, assuming the company discontinues the "Double" brand and they use the "Double" brand sales team to increase the sales of "Queen" mattresses by 20% and to increase the sales of "King" mattresses by 30%.
e. Write a brief note explaining your observations in part d., including a recommendation of whether to proceed with the proposal in part d.