BUS 5110 Managerial Accounting

Group 0009 Project

Assignment One: Break-even Analysis
Review of High End and Economical Washer/Dryer sets

   
Break-even Analysis
 Case Study
 Management has provided the following revenue and cost information:

High-End Set Economical Set

Sales price     $3,500  per unit     $1,000  per unit  
Labor    $875  per unit    $250  per unit
Materials    $1400  per unit    $300  per unit

Direct fixed costs     $25,000  per month    $16,500  per month

Allocated fixed costs     $85,000  per month    $85,000  per month

 Management has asked for the following:

 Break-even quantities for each product line
 Break-even quantities to earn $500,000 per year margin on the high-end line (at the current sales price)
 Break-even quantities to earn $300,000 per year margin on the economical line (at the current sales price)
 They expect the product lines to fully absorb the costs allocated to them.

   
Break-even Analysis
 Approach to the problem
 Find the total variable costs and total fixed costs
 Total Variable costs is sum of labor and materials
 Total fixed costs is the sum of direct and allocated fixed costs
 Find the Contribution Margin (CM) for break-even scenario and break-even + net income Scenarios
 Contribution margin is the amount each unit sold contributes to covering fixed costs and increasing profit (Heisinger &
Hoyle, 2012, p. 397).
 We calculate it by subtracting variable costs per unit (V) from the selling price per unit (S). or
 Equation: CM (@ break-even) = Fixed Costs +Net Income
 Net income is $0 or for break-even or the target margin for net income scenarios

 Find contribution margin ratio, which is the contribution margin as a percentage of sales (Heisinger & Hoyle,
2012, p. 398).
 Equation: contribution margin ratio = Contribution Margin/ [Sales (units) x Units (month)]
 Find break-even quantities for month and annual
 Equation Break-even (Units) = Contribution margin/ [Sales Price – Variable costs]
 Note: Round up to whole units

   
 Break-even Analysis
High-End Economical
     
Set Set Total variable costs is the sum of labor and materials
Sales price  $ 3,500  per unit  $ 1,000  per unit  
         

Labor $ 875  per unit $ 250  per unit Total fixed costs is the sum of direct and allocated fixed costs
Materials $ 1,400  per unit $ 300  per unit
Total Variable costs $ 2,275  per unit $ 550  per unit
          Contribution Margin = Fixed Costs +Net Income
Direct fixed costs  $ 25,000  per month $ 16,500  per month Note: Net income is $0 or for break-even or the target margin for net income scenarios
Allocated fixed costs  $ 85,000  per month $ 85,000  per month
Total Fixed costs $110,000  per month $101,500  per month
Contribution margin ratio = Contribution Margin/ ( Sales price x Units )

  Break even   Break even  

Contribution margin $ 1,125 per unit $ 449 per unit Equation Break-even (Units) = Contribution margin/ [Sales Price – Variable costs]
Contribution margin $1,320,000  per year $1,218,000  per year Note: Round up to whole units
Contribution margin
   
ratio 35% 45%
Break Even Units 1078 per year 2707 per year

To earn To earn SUMMARY OF FINDINGS

  $500,000   $300,000    High-End Set:
Contribution margin $1,820,000  per year $1,518,000  per year
 At break-even the contribution margin $1,125 per unit, $1,320,000 per
Units (Annual) 1,486 per year 3,373 per year
year with a CM ratio of 35%
 To break-even 1078 units must be built per year
 To make a $500,000 margin, 1,486 units need to be built per year
 Economical Set:
 At break-even the contribution margin $449 per unit, $1,218,000 per
year with a CM ratio of 45%
 This model has a higher CM ratio
 To break-even 2707 units must be built per year
 To make a $300,000 margin, 3,373 units need to be built per year

   
Assignment Two: Capital Budget
Machinery and equipment for combination washer-dryer line set up

   
Capital Budget
 Case Study:
 Sales price is expected to be $2,250 per unit, with $595 per unit in labor expense and $795 per unit in materials.
 Year 1 revenue is 55% of the Break-Even sales
 Year 2 revenue is break-even sales
 Year 3, 4 and 5 revenue are increasing by 10%, 15% and 20% respectively
 Year 3, 4 and 5 variable costs increased by 2% year over year
 Initial cash outlay is $150,000, no residual value.
 Direct fixed costs are estimated to run $20,750 per month.
 The required rate of return is 10%.
 Cost of capital is 8%. This is needed for analysis
 Management is requesting:
 The product’s contribution margin
 Break-even quantity
 NPV - the value of cash flows in today’s dollars, adding and subtracting the present value of cash inflows and outflows for a long-term investment
(Heisinger & Hoyle, 2012, p. 606).
 Investment accepted if the NPV is greater than or equal to zero.

 IRR – the required rate to get an NPV of zero and represents the time-adjusted rate of return for an investment (Heisinger & Hoyle,
2012, p. 612).
 Investment is accepted If the IRR is greater than or equal to the company’s required rate of return.

   
Capital Budget
 Approach to the problem:
 The product’s contribution margin
 Find the contribution margin ratio for each year
 Year 2 is break-even so CM will equal fixed costs
 Calculate sales for years 1,3-5
 CM (Years 1,3-5) = sales x cm ratio
 Break-even quantity
 Break-even in dollars will equal Year 2 Revenue
 Beak-even in units will equal Year 2 revenue divided by sales price
 Round up to whole units
 NPV
 Find Total cash in (out) for each year – subtract Total direct variable costs and fixed costs from revenue
 Identify the PV factor using the required rate of return of 10%. This is taken from table in Heisinger & Hoyle’s Accounting
for managers (2012, p. 643)
 Multiply total cash with PV factor for each year (0 – 5) and then sum the values to find NPV
 IRR
 Found using Excel formula: =IRR(B20:G20,0.1)
 B20:G20 represents total cash in (out) for years 0-5
 0.1 represents the required rate of return

   
Capital Budget

 Unit Costs

Year Year Year Year Year

Unit costs 1 2 3 4 5

Sales price $ 2,250 $ 2,250 $ 2,250 $ 2,250 $ 2,250

Material cost $ 795 $ 795 $ 811 $ 827 $ 844 Material and labor increase 2% in Years 3-5

Labor cost $ 595 $ 595 $ 607 $ 619 $ 631

Total variable costs sums the materials and labor costs
Total Variable costs $ 1,390 $ 1,390 $ 1,418 $ 1,446 $ 1,475
CM per unit = sales price -variable costs
Contribution
margin (unit) $ 860 $ 860 $ 832 $ 804 $ 775
CM ratio for each year- will be used in Annual calculations

CM ratio 38.22% 38.22% 36.99% 35.73% 34.44%

   
 Capital Budget
Present Year Year Year Year Year
Timeline (Annual) 0 1 2 3 4 5 Year 2 revenue = CM/CM ratio
Break-even in dollars is $651,453
Revenue $358,299 $651,453 $716,599 $824,089 $988,906
Material cost $127,200 $230,550 $258,677 $303,552 $371,211
Labor cost $95,200 $172,550 $193,601 $227,187 $277,824
Year 2 is break-even, so CM will equal fixed costs
Total Direct Variable costs $222,400 $403,100 $452,278 $530,739 $649,035 CM (Years 1,3,4,5 ) = sales x cm ratio

Initial cash outlay $150,000

Direct Fixed Costs $249,000 $249,000 $249,000 $249,000 $249,000
Multiply total cash with PV factor for years (0 – 5)
Total direct fixed costs $150,000 $249,000 $249,000 $249,000 $249,000 $249,000 and then sum the values to find NPV
Contribution margin $136,950 $249,000 $265,046 $294,417 $340,589

CM ratio 38.22% 38.22% 36.99% 35.73% 34.44%

Total cash in (out) -$150,000 -$113,101 -$647 $15,321 $44,349 $90,872 Excel formula: =IRR(B20:G20,0.1)
PV Factor (rate of return = B20:G20 represents total cash for years 0-5
10%) 1.00000 0.90909 0.82645 0.75131 0.68301 0.62092 the required rate of return is 0.10
NPV -$150,000 -$102,819 -$534 $11,511 $30,291 $56,424 -$155,127
IRR -12.84%
break-even in units is Year 2 revenue divided by
sales price
Units (Break-even Year 2) 160 290 319 367 440
Round up to whole units

 Summary & recommendation:

 Negative NPV points to rejecting investment
 IRR lower than cost of capital of 8% points to rejecting the investment
 Qualitative factors should be considered: Strategic importance to product portfolio, Leader in industry & innovation
 Recommend to go forward with investing in product line for washer/dryer combination product line
   
Assignment Three: Differential Analysis
Analysis to decide to keep or drop the combination washer-dryer

   
Differential Analysis
 Case Study
 management has provided the following information:

High-End Economical  W/D

Total
Set  Set  Combo 
 Sales   $4,700,000     $4,060,000    $880,000     $9,640,000

 Labor   $(1,250,000)   $(1,015,000)   $(235,000)   $(2,500,000)

 Materials   $(1,885,000)   $(1,220,000)   $(315,000)   $(3,420,000)

 Direct fixed
  $(325,000)   $(220,000)   $(250,000)   $(795,000)
costs 
 Allocated fixed
  $(650,000)   $(650,000)   $(650,000)   $(1,950,000)
costs 
 Net Income    $590,000   $955,000   $(570,000)   $975,000

 Management have asked you to :

 Perform an analysis to determine whether to drop or keep the washer-dryer combination product and present your
findings.
 Evaluate if the costing methodology is appropriate and, if not, recommend alternative methods
   
 Differential Analysis
 Option 1: Keep all product lines  Option 2:Drop Washer/Dryer combo product line
High-End Economical W/D Economical
Set Set Combo Total High-End Set Set Total

Sales $4,700,000 $4,060,000 $880,000 $9,640,000 Sales $4,700,000 $4,060,000 $8,760,000

Labor -$1,250,000 -$1,015,000 -$235,000 -$2,500,000 Labor -$1,250,000 -$1,015,000 -$2,265,000

Materials -$1,885,000 -$1,220,000 -$315,000 -$3,420,000 Materials -$1,885,000 -$1,220,000 -$3,105,000

Direct fixed Direct fixed
costs -$325,000 -$220,000 -$250,000 -$795,000 costs -$325,000 -$220,000 -$545,000
Allocated Allocated
fixed costs -$650,000 -$650,000 -$650,000 -$1,950,000 fixed costs -$1,046,233 -$903,767 -$1,950,000

Net Income $590,000 $955,000 -$570,000 $975,000 Net Income $590,000 $955,000 $895,000

Imp Sales is higher for Option 1 – supports keeping all product lines
or

Impo
t Differential Analysis

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Materials
Labor, is higher for Direct
Option 1 – supports keeping all
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Labor isMaterials,
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Option 1 –Fixed costskeeping
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Differential Option 1 supports all product lines
Option 1 Option 2 Amount is: lines
– supports dropping the washer/dryer combo product line

Sales $9,640,000 $8,760,000 $880,000 Higher Allocated Fixed costs is the same – supports neither
Find difference Labor -$2,500,000 -$2,265,000 -$235,000 Higher
Net Income is higher for Option 1 – supports keeping all product
between two options
Materials -$3,420,000 -$3,105,000 -$315,000 Higher lines
Determine if Option 1 Direct fixed Differential Analysis Summary: Sales and net income are up
is higher or lower costs -$795,000 -$545,000 -$250,000 Higher
supporting our recommendation to keep all product lines. Even
Allocated
fixed costs -$1,950,000 -$1,950,000 $0 - though direct and allocated fixed costs are higher supporting
option 2, this is outweighed by the bottom line results of higher
Net Income $975,000 $895,000 $80,000 Higher net income.
We believe the costing methodology is appropriate
   
References

 Heisinger, K., & Hoyle, J. B. (2012). Accounting for Managers. (1.0). Creative Commons by-nc-sa

3.0. Retrieved from http://lardbucket.org