Question

Laura Publishers publish paperback fiction. The books are sold to wholesalers. Last year sales were Shs.8 million, fixed expenses were Shs.1,760,000 and net profit was Shs.640,000 (8% on sales). The company is now considering the option of eliminating the wholesalers and selling direct to retailers such as supermarkets and other bookstores. A feasibility study estimated that the proposed changes would result in sales of Shs.5,200,000 (a 35% fall) and that the net profit would be Shs.400,000. Fixed expenses would increase to Shs.1,784,000. Required: 1. Calculate the existing and the proposed Contribution Margin. (6 Marks) 2. Calculate the existing and the proposed Break-Even Points. (6 Marks) Indicate by how much the

proposed change would increase or decrease the break-even point? b) State six assumptions of cost-volume- profit analysis.

Answer 1

The existing contribution margin is Shs. 6,240,000 and the proposed contribution margin is Shs. 3,416,000. The existing break-even point is 28% and the proposed break-even point would be 53%, resulting in a 25% increase. The six assumptions of cost-volume-profit analysis are: constant selling price per unit, constant variable expenses per unit, constant total fixed expenses, constant sales mix, everything produced is sold, and linear volume, price, and costs over the relevant range.

Step-by-step explanation:

The existing contribution margin can be calculated by subtracting the variable expenses from the sales. In this case, the existing contribution margin would be Shs. 8,000,000 - Shs. 1,760,000 = Shs. 6,240,000. The proposed contribution margin can be calculated in the same way, using the estimated sales and variable expenses, which would be Shs. 5,200,000 - Shs. 1,784,000 = Shs. 3,416,000.

The existing break-even point can be calculated by dividing the fixed expenses by the existing contribution margin. In this case, the existing break-even point would be Shs. 1,760,000 / (Shs. 8,000,000 - Shs. 1,760,000) = 0.28 or 28%. The proposed break-even point can be calculated in the same way, using the proposed fixed expenses and contribution margin, which would be Shs. 1,784,000 / (Shs. 5,200,000 - Shs. 1,784,000) = 0.53 or 53%. Therefore, the break-even point would increase by 25%.

The six assumptions of cost-volume-profit analysis are:

The selling price per unit is constant.

Variable expenses per unit are constant.

Total fixed expenses are constant.

The sales mix is constant.

Everything produced is sold.

The volume, price, and costs are linear over the relevant range.