4.34 The following table presents the required statement.

Ajax Corporation
Contribution Margin Income Statement for
the most recent Year
Revenue $1,525,000
Cost of goods sold 900,000
Sales commissions 91,500
Variable cost of transport in 6,500
Contribution margin $527,000
Fixed transportation cost 18,000
Administration costs 220,000
Selling costs 148,500
Profit $140,500

Notice that the contribution margin statement regroups the costs into fixed and
variable costs. Moreover, because it is a merchandiser, Ajax buys and sells goods
without substantially transforming them. Thus, its cost of goods sold is a variable
cost; this cost is the amount Ajax would have paid its suppliers. We obtain sales
commissions as 6% of sales revenue (0.06 × $1,525,000 = $91,500). We then back
out fixed selling costs as the remainder ($240,000- $91,500 = $148,500).

4.35 The following table presents the required statement.

Jindal Corporation
Contribution Margin Statement for the most
recent Year
Revenue $2,435,000
Variable cost of goods sold 998,010
Sales commissions 121,750
Contribution margin $1,315,240
Fixed manufacturing costs 248,750
Fixed administration costs 425,000
Fixed selling costs 437,200
Profit $204,290

Notice that the contribution margin statement regroups the costs into fixed and
variable costs. We obtain sales commissions as 5% of sales revenue (0.05 ×
$2,435,000 = $121,750) and back out fixed selling costs as the remainder ($558,950 -
121,750 = $437,200).
 4.36 Fabricare’s GAAP based income statement is as follows:

[EXTB]Fabricare
GAAP income statement for the Most Recent Month
Revenue $8,000,000
Cost of goods sold 4,200,000
Gross Margin $3,800,000
Variable selling costs 800,000
Fixed selling costs 500,000
Fixed administrative costs 450,000
Profit $2,050,000

4.62

a. The key is to realize that the service department currently is incurring the variable costs
associated with all of the repairs, regardless of whether the repairs are internal or external.
However, revenue is only recognized on sales made to external customers (no revenue is recorded
for repairs to cars purchased for inventory or “courtesy” repairs to used cars sold). If the service
department could charge the used car department for these repairs (i.e., as if it were a separate
stand-alone service station), then its revenues would double (since half of their time is spent on such
repairs). Meanwhile, its variable costs would stay at the same level. In addition, the used car costs
would increase by $200,000, reflecting the value of the services received. The revised contribution
margin statement below reflects these changes:

Used Cars Service Total

Revenue $2,500,000 $200,000 $2,700,000
Revenue – used cars ----------- 200,000 200,000
Variable costs 1,200,000 200,000 1,400,000
Service costs 200,000 ----------- 200,000
Contribution Margin $1,100,000 $200,000 $1,300,000
Traceable fixed costs 750,000 250,000 1,000,000
Segment Margin $350,000 ($50,000) $300,000
Common fixed costs 200,000
Profit before Taxes $100,000

Carousel’s overall profit has not changed – it remains at $100,000. The revised income statement
simply paints a “truer” picture regarding the stand-alone revenues and costs associated with each of
Carousel’s departments.

b. Based on the nature of the common fixed costs, it is unlikely that these costs will
decrease if the service department is closed. All other revenues and costs associated with
the service department, however, likely will go away. As calculated in part [a], the service
department is losing $50,000 before considering common fixed costs – thus, all other things
being the same, Carousel’s profit is expected to increase by $50,000 if the service
department were closed. This effect also can be seen (and verified) by constructing an
income statement with used car sales only. We present such an income statement below
(again, this income statement assumes that the used car department will pay for minor
repairs on the cars it buys and still provide courtesy repairs and maintenance on used car
purchases – all of this will be done via an independent service station at market price, or
$200,000 as calculated earlier):

Used Cars
Revenue $2,500,000
Variable costs* $1,400,000
Contribution margin $1,100,000
Traceable fixed costs $750,000
Common fixed costs $200,000
Profit before Taxes $150,000
* = $1,200,000 + $200,000

Again, we see that Carousel’s overall income is expected to increase by $50,000 to

$150,000.

There are, of course, other factors that should be considered, perhaps the most important
of which relates to the effect on used car sales. For example, it is quite possible that closing
the service department will decrease used car sales. That is, the service department likely
entices customers to look at and purchase a car (e.g., someone who is waiting on a repair
might roam the used car lot). Other considerations relate to whether the entire service
department’s traceable fixed costs will go away (e.g., those related to equipment or space)
and whether some of the common fixed costs will go away (e.g., the general manager’s
salary may decrease since his/her responsibilities have decreased).

c. A 10% decrease in used car sales implies that used auto revenues, variable costs, and
contribution margin will all decrease by 10%. However, it is unlikely that, at least in the
short term, either traceable fixed costs or common fixed costs will decrease. With this, our
revised income statement for used cars looks as follows:

Item Used Cars Detail

Revenue $2,250,000 $2,500,000 ´ .90
Variable costs $1,260,000 $1,400,000 ´ .90
Contribution margin $990,000 $1,100,000 ´ .90
Traceable fixed costs $750,000
Common fixed costs $200,000
Profit before Taxes $40,000
Here, we see that Carousel’s overall income decreases by $60,000 to $40,000. Assuming
the accuracy of the various estimates underlying the revised income statement, Carousel
should not close the service department. This problem underscores the importance of
considering interdependencies among departments and/or products – oftentimes it is
difficult to evaluate products or departments on a “stand alone” basis. Moreover, the
contribution margin statement helps us assess these interdependencies.

4.68
a. Casey’s annual customer contribution statement is presented below:

Annual Customer Contribution Statement

Item Commercial Residential Total
Fee per engagement $150 $80
Engagements per week 6 6
Revenue per week $900 $480 $1,380

Variable Costs per week

Supplies1 180 120 300
Cost of labor2 450 180 630
Weekly contribution margin $270 $180 $450
# of weeks 50 50 50
Annual Contribution Margin $13,500 $9,000 $22,500

Traceable fixed costs

Advertising cost $5,000 $5,000
Direct equipment $1,500 1,500
Hired help for 2 weeks3 300 300
Segment Margin $11,700 $4,000 $15,700

Common fixed costs

Common equipment4 $5,500
Office Expenses $1,500
Profit before Taxes $8,700
1 $180 = $30 × 6; $120 = $20 × 6
2 $450 = 10 hours per day × $15 per hour × 3 days per week; $180 = 6 hours per day × $15 per hour × 2 days
per week;
3 = 6 motels per week × 2 weeks × ($175 cost – $150 fee). Note: We classify this as a traceable fixed cost as it is

a constant amount per year and it is purely associated with Casey’s motel business.
4 = $7,000 – $1,500 in equipment attributable solely to motel cleaning jobs.

Thus, we see that Casey earns a total of $8,700 in profit + ($630 × 50 weeks per year) = $40,200 in
proceeds from his cleaning business. We also see the source of Casey’s concern – he earns $300/10
= $30 per hour in revenue from the motels and $240/6 = $40 per hour in revenue from his
residential business. This, however, does not take into consideration the differential costs incurred
to serve the residences and motels. Indeed, the segment margins seem to indicate that the motel
business is more profitable than the residential business – we explore this further below.

b. Casey should not drop his motel business. His profit from doubling his residential
business is:

Twice the current contribution margin $18,000

Less: Advertising 10,000
Less: Common equipment 5,500
Less: Office expenses 1,500
Profit before Taxes $1,000

Adding his wages, Casey receives $1,000 + (30 hours per week × $15 per hour × 50 weeks
per year) = $23,500 in proceeds from his business. Thus, Casey receives $40,200 – $23,500 =
$16,700 less in annual proceeds if he drops the motel business.

However, Casey would be putting in fewer hours if he drops the motel business (i.e.,
comparing proceeds is not an “apples to apples” comparison). Casey saves (10 – 6) × 3 days
per week × 50 weeks per year = 600 hours per year, and if he values this time at $15 per
hour, this amounts to $9,000 = (600 hours × $15 per hour). This savings, however, does not
make up for the $16,700.

We do note the importance of being careful when using estimates for the opportunity cost
of time. We are implicitly assuming that Casey values his time at $15 per hour, regardless of
the number of hours of leisure. This may not be a reasonable assumption as there is
decreasing marginal utility for any normal good. This problem underscores the value of
contribution margin statements and their ability to aid decision making.

5.33
a. A 50% increase changes Ajay’s variable costs from $1.00 per package to $1.00 ´ (1 +
.50), or $1.50 per package.

Consequently, the revised unit contribution margin = $3.00 – $1.50 = $1.50 per
package.

Setting target profit to zero in the expression for profit, we obtain:

0 = $1.50 ´ Breakeven volume – $600.

OR, Breakeven volume = = 400 packages.

b. Writing-out Ajay’s profit in detail, we have:

Profit before taxes = (Price – Unit variable cost) ´ number of packages – Fixed costs.
Substituting using the given data, we have:
 $2,400 = (Price – $1.00) ´ 3,000 – $600.
OR, Price = $2.00.

5.38

a. Since profit and taxes = $0 at the breakeven point, we know that the
profit expression reduces to:

$0 = $1.00 ´ Breakeven volume – $600,000.

Thus, Breakeven volume = 600,000 pounds.

b. SpringFresh’s profit before taxes = ($1.00 ´ 750,000 pounds) –

$600,000 = $150,000.

Taxes paid = $150,000 ´ .25 = $37,500.

Profit after taxes = $150,000 ´ .75 = $112,500.

5.39
a)Profit after taxes = [(Unit contribution margin × Quantity) – Fixed costs] ´ (1 – Tax
rate).

$120,000 = [($1.00 ´ Required volume in pounds) – $600,000] × .75.

Thus, Required volume = 760,000 pounds.

5.41

a)For Arena, the contribution margin ratio is 1 – 0.30 = 0.70 (70% of billings).

Further, Arena’s monthly fixed costs = $14,000 and the tax rate is 35%.

Consequently, Arena’s monthly profit is:

Profit after taxes = [(.70 ´ Billings) – $14,000] × .65.

At the breakeven point, profit after taxes = profit before taxes = $0 (i.e., no tax is due
because there is no profit). Consequently, we have (since the tax rate is irrelevant at
breakeven):

$0 = (0.70 ´ Breakeven revenue) – $14,000.

 Solving, we find breakeven billings = $20,000.

b.Using the profit expression in [a], we have:

Profit before taxes = (0.70 ´ $50,000) – $14,000 = $21,000.

Profit after taxes = $21,000 ´ .65 = $13,650.

c. Again, using the profit expression in (a), we have:

$7,280 = [(0.70 ´ Required billings) – $14,000] × .65.

Required billings = $36,000.

5.43
Employing the CVP relation, we can compute the profit at alternative prices to
determine the price that yields the maximum profit. The following table contains the
detailed computations.

Variable
Price Revenue Costs Fixed Costs Profit
$32.50 $9,750 $1,800 $3,000 $4,950
$30.00 $10,500 $2,100 $3,000 $5,400
$27.50 $11,000 $2,400 $3,000 $5,600
$25.00 $11,250 $2,700 $3,000 $5,550
$22.50 $11,250 $3,000 $3,000 $5,250

By inspection, we find $27.50 to be the profit-maximizing price. Greg earns $5,600

in profit at this price.

5.46

a.Let us employ a weighted unit contribution margin approach to solve the problem.
For Mountain Maples, we have:

2,400 total trees sold – 800, or 1/3 are Butterfly, and 1,600, or 2/3, are Moonfire.
Thus, we have:

Weighted unit contribution margin = 1/3 ´ $100 + 2/3 ´ $50.

= $66.67.
 In turn, Mountain Maples’ profit becomes:

Profit before taxes = ($66.67 ´ total number of trees sold) – $75,000.

At the breakeven point, we have: $0 = ($66.67 ´ Breakeven number of trees) –

$75,000.

Solving, we find that the total number of trees sold to breakeven = 1,125.

Of these, 1,125 ´ 1/3 = 375 Butterfly; 1,125 ´ 2/3 = 750 Moonfire.

b.Using the weighted unit contribution margin approach, we have:

$50,000 = ($66.67 ´ total number of trees) – $75,000.

The total number of trees = 1,875.

Of these, 1,875 ´ 1/3 = 625 are Butterfly, and

1,875 ´ 2/3 = 1,250 are Moonfire

c.The change in the product mix affects Mountain Maple’s weighted contribution.

With the new information, we have:

Weighted contribution margin = (.50 ´ $100) + (.50 ´ $50)

= $75.00

The weighted contribution margin is higher than in part [a] because the product mix
has shifted toward Butterfly, which has the highest contribution margin per tree.

Consequently, the total number of trees required to break even will decrease:

0 = ($75.00 ´ Breakeven number of trees) – $75,000.

Breakeven number of trees = 1,000.

Of these, 1,000 ´ .50 = 500 are Butterfly, and

1,000 ´ .50 = 500 are Moonfire

5.48

In this setting, we must use the weighted contribution margin ratio approach given the
absence of unit-level data. Accordingly,:

Profit before taxes = (RevenueN ´ Contribution margin rationN) +

(RevenueU ´ Contribution margin ratioU) – Fixed costs,
The subscripts ‘N’ and ‘U’ stand for new and used. Additionally, we know that
$1,500,000/$2,000,000, or 75% of the revenue is from new cars, and
$500,000/$2,000,000, or 25% of the revenue is from used cars.

Further, we can calculate the contribution margin ratio for each product using the
product-level financial data. We have:

(Contribution margin ratio)N = = .50.

(Contribution margin ratio)U = = .60.

Thus, the weighted contribution margin ratio = (.50 × .75) + (.60 × .25) = .525.

We can now write Select’s profit in terms of the weighted contribution margin ratio
and total revenues:

Profit before taxes = (.525 × Total revenue) – $840,000.

Setting profit equal to $0, we find:

Breakeven total revenue = $1,600,000.

This translates into $1,600,000 ´ .75 = $1,200,000 in new auto sales and $1,600,000 ´
.25 = $400,000 in used auto sales.

b.To answer this question, we plug in our desired profit in the equation for profit
developed in part [a]. We now have:

$1,050,000 = (.525 ´ Total revenue) – $840,000.

Solving, we find:

Total revenue = $3,600,000.

This translates into $3,600,000 ´ .75 = $2,700,000 in new auto sales and $3,600,000 ´
.25 = $900,000 in used auto sales.

5.62

a)Tornado’s profit for the most recent year can be calculated as follows:
 F1 F3 F5 Total
Revenues* $3,750,000 $3,000,000 $4,000,000 $10,750,000
Variable costs** $1,875,000 $1,650,000 $2,400,000 $5,925,000
Contribution margin $1,875,000 $1,350,000 $1,600,000 $4,825,000
Fixed costs $3,860,000
Profit $965,000

* = quantity sold ´ selling price per unit

** = quantity sold ´ variable cost per unit

b.There are at least two ways to answer this question. The longer and more tedious
way is to convert the increase (decrease) in sales to units for each of the three
alternatives – i.e., assume that Tornado focuses its advertising campaign on the F1,
F3, or F5 market. We can then multiply the sales quantities by the appropriate
contribution margin to compute the net increase in margin under each alternative.
Naturally, we select the option with the highest margin.

The second, and more straightforward, approach is to use contribution margin ratios
– which deal with dollars directly. Using the given data, we have:

F1 F3 F5
Selling price per unit $150 $200 $400
Variable cost per unit $75 $110 $240
Contribution margin .50 .45 .40
ratio*

* = (unit selling price – unit variable cost)/ unit selling price

That is, an increase of $1 in sales yields the greatest contribution if it is from the F1
market. Consequently, it makes most sense for Tornado to focus its campaign on the
F1 market. The net effect on profit will be:

Gain from F1 market $300,000 .50 ´ $600,000

Loss from F3 market ($27,000) .45 ´ $60,000
Loss from F5 market ($24,000) .40 ´ $60,000
Increase in fixed costs ($150,000) given
Net increase in profit $99,000

The skeptical student may wish to construct tables assuming the advertising
campaign were focused on the F3 or F5 market to verify that the strategy of focusing
on these markets indeed leads to lower profit than focusing on the F1 market.

This problem is useful in highlighting the difference between unit contribution

margins and contribution margin ratios. The unit contribution margin calculates the
absolute profit, and the contribution margin ratio calculates profitability. Thus, we
see that although the F5 has the largest contribution margin and, thus, on a per unit
basis contributes the most to absolute profit, it has the lowest profitability per $1 of
sales.
c.Management is making a number of assumptions. First, they are assuming that
the advertising campaign will work and lead to a substantial increase sales for
the targeted vacuum cleaner. Second, by assuming that the increase in revenue
will be constant at $600,000 regardless of the vacuum cleaner chosen,
management is assuming that the “demand kick” in units will be smallest for the
F5 and largest for the F1 (the F3 will be in the middle). Specifically, estimated
demand for each vacuum cleaner, should it be selected is:
F1: $600,000/150 = 4,000 units.
F3: $600,000/200 = 3,000 units.
F5: $600,000/400 = 1,500 units.
These proportions are roughly comparable to the current sales mix. Moreover,
management is assuming that the market is “thinner” for the F1 and “thicker” for
the F5 – this assumption makes some sense since, ceteris paribus, as price increases
we expect quantity demanded (in aggregate) to decrease, particularly when there
are substitute products available.
Finally, management is assuming that the advertising campaign will cannibalize
existing sales – in other words, if the advertising campaign were targeted toward the
F3 market, some consumers who would have purchased the F1 or the F5 would,
instead, purchase the F3. Again, the constant loss in revenue assumption stipulates
that fewer F5 customers will defect than F1 customers, and so on. Moreover, this
assumption reflects that while the vacuum cleaners are, to some extent, substitutes,
the elasticity of demand likely differs across the products.

5.66 Rick’s English Hut.

a.Currently, Rick’s is generating $60,000 in sales. For alcohol and food, this translates
to:

Alcohol Sales: $60,000 ´ .55 = $33,000, or $33,000/$4 = 8,250 “alcohol units.”

Food Sales: $60,000 ´ .45 = $27,000, or $27,000/$5 = 5,400 “food units.”

Monthly profit can then be calculated as:

[8,250 ´ ($4 – $2)] + [5,400 ´ ($5 – $4)] – $10,950 = $10,950.

Because the proportions are defined in terms of revenue, it may be easier to solve
the problem using a contribution margin ratio approach.

The contribution margin ratio for food = (5 – 4)/5 = .20, and the contribution margin
ration for alcohol is (4 – 2)/4 = .50.

Thus, the profit can be calculated as:

Profit = ($33,000 ´ 0.50) + ($27,000 ´ 0.20) – $10,950 = $10,950.

To determine breakeven sales, we need to calculate a weighted contribution margin

ratio. Since 45% of revenue is from food and 55% is from alcohol, we have:

Weighted contribution margin ratio = (0.45 ´ 0.20) + (0.55 ´ 0.50) = 0.365 or 36.5%.

The profit is then:

Profit = Weighted contribution margin ratio ´ Total Revenue – Fixed cost.

At the breakeven point, we have:

$0 = 0.365 ´ Breakeven revenue – $10,950.

Breakeven revenue = $30,000.

Note: It is tempting to calculate a weighted unit contribution margin as (0.45 ´ $1) +

(0.55 ´ $2) = $1.55 – this is not appropriate, though, because the weights are the
ratio of revenue and not the ratio of the number of units sold.

For weighted unit contribution margin, we use unit contribution margins; the
weights must also be the ratio of units. If students employ this approach, the
weighted unit contribution margin = $1.60.

For weighted contribution margin ratio, we use the contribution margin ratio (i.e.,
contribution per revenue dollar); thus, the weights must be the ratio of revenue.
Students can go awry because they combine the revenue weights with unit
contribution margins.

b.Under this option, the proprietors of Rick’s have decided to change the licensing
status from a restaurant to a bar. In terms of calculating profit, revenue stays the
same but Rick’s fixed costs have changed. Accordingly, we have:

Profit = ($60,000 ´ 0.365) – $10,950 – $850 – $318 = $9,782.

Rick’s monthly profit has decreased by $1,168, which is the exact amount by which
fixed costs have increased.

For the breakeven point, the weighted contribution margin ratio stays the same; the
fixed costs, however, increase by $1,168 to $12,118:

Thus, Breakeven revenue = $12,118/0.365 = $33,200.

As would be expected, the breakeven point in revenue has increased.

c. Under the second option, Rick’s plans on closing early so that alcohol sales equal
the current level of food sales (the revenues from both products are equal). With
the new sales mix, the Weighted contribution margin ratio is:

Weighted contribution margin ratio (option 2) = 0.5 ´ 0.2 + 0.5 ´ 0.5 = 0.35.

Additionally, total revenues = $27,000 + $27,000 = $54,000 and fixed costs have
decreased by $450 to $10,500. Thus, we have:

Profit = $54,000 ´ 0.35 – $10,500 = $8,400.

This action has reduced Rick’s profit by $2,550 and, at this point, Rick’s would prefer
option 1 over option 2.

We also have:

$0 = 0.35 ´ Breakeven revenue – $10,500.

Breakeven revenue = $10,500/0.35 = $30,000.

Notice that, compared to part [a] Rick’s breakeven point in revenue has stayed the
same even though total fixed costs have decreased. This occurs because the sales-
mix has shifted to a higher proportion of food items, which is the lower contribution
margin product.

Notice also that compared to option 1, the breakeven revenue is lower under option
2 (although profit is higher under option 1). The increase in fixed costs under option
1 requires Rick’s to sell more to breakeven – however, it does not restrict the
percentage of alcohol sales, so the upside potential is higher. If Rick’s can maintain
their current level of sales, they likely would pursue option 1 and bar status.

d. Under this option, Rick’s is planning to offer a brunch to make up for the revenue
shortfall from current food sales. From part [a], we know that the difference in
revenue is $6,000; thus, 6,000/4 = 1,500 brunches need to be sold on the
weekends. The brunches also have a negative contribution of -0.08 or a
contribution margin ratio of -0.02 = ($4 – $4.08)/$4.

The mix of the revenue has also changed. The new weighted contribution margin
ratio is:

Weighted contribution margin ratio = (27/66) ´ 0.2 + (33/66) ´ 0.5 + (6/66) ´ (-0.02) =
0.33.

With this Weighted contribution margin ratio, Rick’s profit is:

Profit = 0.33 ´ $66,000 – $10,950 – $105 = $10,725.

 Notice that this turns out to be Rick’s best option – profit is only $225 lower than the
most recent month.

For the breakeven point, we have:

Breakeven revenue = Fixed cost/ Weighted contribution margin ratio = $11,055/0.33

= $33,500.

Notice that compared to option 1, the breakeven revenue is highest under option 3,
although it is still considerably below the current sales level of $60,000 (and
anticipated sales level of $66,000). Profit also is $943 higher than option 1 and
$2,325 higher than option 2.

All in all, Rick’s would be hard-pressed not to select option 3.

e. Rick’s has learned the value and importance of profit planning at the portfolio
(aggregate or business) level rather than at the individual product level. What in
isolation appears to be a poor strategy, selling a product at a loss, turns out to be
the best strategy for the business as a whole. In essence, when companies offer
multiple products or services they need to consider the relationships/externalities
among these products and services. The profitability of the business as a whole is
of utmost concern, not the profitability of individual products and services.

We frequently see such behavior by restaurants and bars – an establishment offers

very cheap food/appetizers (e.g., happy hours) to stimulate demand for higher
margin alcohol sales. In a similar vein, we also observe restaurants offering “kids eat
free” nights.

Casinos in Las Vegas or Atlantic City perhaps provide the prototypical example of this
behavior. Casinos routinely offer “loss leaders” such as low-price meals (e.g., buffets
for $2 or $3), free drinks, and heavily discounted hotel rooms in order to attract and
retain customers on the more highly profitable gambling activities. Casino owners
make such concessions and offer “comps” to increase profit on their primary product
line.

Yet another example is banks – banks routinely offer free checking in an attempt to
get customers to keep their savings in the bank and/or purchase higher margin home
or auto loans. Finally, supermarkets frequently offer loss leaders – they advertise
specials on milk, bread, eggs, and the like. Such items are commonly purchased
goods and attract customers to the store. Once inside the store, supermarkets hope
that customers do the remainder of their shopping there, buying fruits and
vegetables, meats, chips, soda, and so on.

In all the examples, the fundamental point stays the same – it is important to do
profit planning and such planning is appropriately done at the “portfolio” level. In
short, the case makes a critical point – we need to think about the
interdependencies among the products and services being offered.