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. (3 marks)

Answer 1

The existing Contribution Margin is Shs.5,600,000 and the proposed Contribution Margin is Shs.4,800,000. The existing Break-Even Point is approximately 31.43% and the proposed Break-Even Point is approximately 37.2%, indicating an increase of approximately 5.77%. The six assumptions of cost-volume-profit analysis are the sales mix remains constant, the behavior of costs and revenues is linear, fixed costs remain constant, variable costs remain constant per unit, there is no change in inventory levels, and all revenues and costs can be accurately identified and measured.

Step-by-step explanation:

The existing Contribution Margin can be calculated using the formula:

Contribution Margin = Sales - Total Variable Expenses

Given that last year sales were Shs.8 million, net profit was Shs.640,000 and fixed expenses were Shs.1,760,000, we can calculate the existing Contribution Margin as:

Contribution Margin = Shs.8,000,000 - Shs.640,000 - Shs.1,760,000 = Shs.5,600,000

The proposed Contribution Margin can be calculated using the same formula, but with the new sales and variable expenses:

Contribution Margin = Shs.5,200,000 - Shs.400,000 = Shs.4,800,000

The existing Break-Even Point can be calculated using the formula:

Break-Even Point = Fixed Expenses / Contribution Margin

Given that fixed expenses were Shs.1,760,000 and the existing Contribution Margin is Shs.5,600,000, we can calculate the existing Break-Even Point as:

Break-Even Point = Shs.1,760,000 / Shs.5,600,000 = 0.3143 (approximately 31.43%)

The proposed Break-Even Point can be calculated using the same formula, but with the new fixed expenses and proposed Contribution Margin:

Break-Even Point = Shs.1,784,000 / Shs.4,800,000 = 0.372 (approximately 37.2%)

The proposed change would increase the Break-Even Point by approximately 5.77% (37.2% - 31.43% = 5.77%).

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

1. The sales mix remains constant.
2. The behavior of costs and revenues is linear throughout the relevant range.
3. Fixed costs remain constant.
4. Variable costs remain constant per unit.
5. There is no change in inventory levels.
6. All revenues and costs can be accurately identified and measured.