# target profit analysis neptune company produces toys B u s i n e s s F i n a n c e

target profit analysis neptune company produces toys B u s i n e s s F i n a n c e

Part A: Changes in Fixed and Variable Costs; Break-Even and Target

Profit Analysis

Neptune Company produces toys and other items for use in beach and resort areas. A

small, inflatable toy has come onto the market that the company is anxious to produce

and sell. The new toy will sell for \$2.80 per unit. Enough capacity exists in the

company’s plant to produce 30,300 units of the toy each month. Variable expenses to

manufacture and sell one unit would be \$1.78, and fixed expenses associated with the

toy would total \$45,859 per month.

The company’s Marketing Department predicts that demand for the new toy will exceed

the 30,300 units that the company is able to produce. Additional manufacturing space

can be rented from another company at a fixed expense of \$2,293 per month. Variable

expenses in the rented facility would total \$1.96 per unit, due to somewhat less efficient

operations than in the main plant.

Required:

1. What is the monthly break-even point for the new toy in unit sales and dollar sales.

2. How many units must be sold each month to attain a target profit of \$10,752 per

month?

3. If the sales manager receives a bonus of 20 cents for each unit sold in excess of the

break-even point, how many units must be sold each month to attain a target profit that

equals a 24% return on the monthly investment in fixed expenses?

(For all requirements, Round “per unit” to 2 decimal places, intermediate and final

answers to the nearest whole number.)

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Part B: CVP Applications; Contribution Margin Ratio; Break-Even

Analysis; Cost Structure

Due to erratic sales of its sole product—a high-capacity battery for laptop computers—

PEM, Inc., has been experiencing financial difficulty for some time. The company’s

contribution format income statement for the most recent month is given below:

Required:

1. Compute the company’s CM ratio and its break-even point in unit sales and dollar

sales.

2. The president believes that a \$6,700 increase in the monthly advertising budget,

combined with an intensified effort by the sales staff, will result in an \$85,000 increase

in monthly sales. If the president is right, what will be the increase (decrease) in the

company’s monthly net operating income?

3. Refer to the original data. The sales manager is convinced that a 10% reduction in

the selling price, combined with an increase of \$35,000 in the monthly advertising

budget, will double unit sales. If the sales manager is right, what will be the revised net

operating income (loss)?

4. Refer to the original data. The Marketing Department thinks that a fancy new

package for the laptop computer battery would grow sales. The new package would

increase packaging costs by \$0.60 per unit. Assuming no other changes, how many

units would have to be sold each month to attain a target profit of \$4,800?

5. Refer to the original data. By automating, the company could reduce variable

expenses by \$3 per unit. However, fixed expenses would increase by \$53,000 each

month.

a. Compute the new CM ratio and the new break-even point in unit sales and dollar

sales.

b. Assume that the company expects to sell 20,300 units next month. Prepare two

contribution format income statements, one assuming that operations are not

automated and one assuming that they are. (Show data on a per unit and percentage

basis, as well as in total, for each alternative.)

c. Would you recommend that the company automate its operations (Assuming that the

company expects to sell 20,300)?

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Part C: Relevant Cost/Special Order Decisions

Polaski Company manufactures and sells a single product called a Ret. Operating at

capacity, the company can produce and sell 30,000 Rets per year. Costs associated

with this level of production and sales are given below:

The Rets normally sell for \$50 each. Fixed manufacturing overhead is \$270,000 per

year within the range of 25,000 through 30,000 Rets per year.

Required:

1. Assume that due to a recession, Polaski Company expects to sell only 25,000 Rets

through regular channels next year. A large retail chain has offered to purchase 5,000

Rets if Polaski is willing to accept a 16% discount off the regular price. There would be

no sales commissions on this order; thus, variable selling expenses would be slashed

by 75%. However, Polaski Company would have to purchase a special machine to

engrave the retail chain’s name on the 5,000 units. This machine would cost \$10,000.

Polaski Company has no assurance that the retail chain will purchase additional units in

the future. What is the financial advantage (disadvantage) of accepting the special

order?

2. Refer to the original data. Assume again that Polaski Company expects to sell only

25,000 Rets through regular channels next year. The U.S. Army would like to make a

one-time-only purchase of 5,000 Rets. The Army would pay a fixed fee of \$1.80 per Ret,

and it would reimburse Polaski Company for all costs of production (variable and fixed)

associated with the units. Because the army would pick up the Rets with its own trucks,

there would be no variable selling expenses associated with this order. What is the

3. Assume the same situation as described in (2) above, except that the company

expects to sell 30,000 Rets through regular channels next year. Thus, accepting the

U.S. Army’s order would require giving up regular sales of 5,000 Rets. Given this new

information, what is the financial advantage (disadvantage) of accepting the U.S. Army’s

special order?

Part D: Relevant Cost/Make or Buy Decision

Silven Industries, which manufactures and sells a highly successful line of summer

lotions and insect repellents, has decided to diversify in order to stabilize sales

throughout the year. A natural area for the company to consider is the production of

winter lotions and creams to prevent dry and chapped skin.

After considerable research, a winter products line has been developed. However,

Silven’s president has decided to introduce only one of the new products for this coming

winter. If the product is a success, further expansion in future years will be initiated.

The product selected (called Chap-Off) is a lip balm that will be sold in a lipstick-type

tube. The product will be sold to wholesalers in boxes of 24 tubes for \$14 per box.

Because of excess capacity, no additional fixed manufacturing overhead costs will be

incurred to produce the product. However, a \$130,000 charge for fixed manufacturing

overhead will be absorbed by the product under the company’s absorption costing

system.

Using the estimated sales and production of 130,000 boxes of Chap-Off, the Accounting

Department has developed the following manufacturing cost per box:

The costs above relate to making both the lip balm and the tube that contains it. As an

alternative to making the tubes for Chap-Off, Silven has approached a supplier to

discuss the possibility of buying the tubes. The purchase price of the supplier’s empty

tubes would be \$1.95 per box of 24 tubes. If Silven Industries stops making the tubes

and buys them from the outside supplier, its direct labor and variable manufacturing

overhead costs per box of Chap-Off would be reduced by 10% and its direct materials

costs would be reduced by 20%.

Required:

1. If Silven buys its tubes from the outside supplier, how much of its own Chap-Off

manufacturing costs per box will it be able to avoid? (Hint: You need to separate the

manufacturing overhead of \$2.50 per box that is shown above into its variable and fixed

components to derive the correct answer.)

tubes from the outside supplier?

130,000 boxes of tubes from the outside supplier?

4. Should Silven Industries make or buy the tubes?

5. What is the maximum price that Silven should be willing to pay the outside supplier

for a box of 24 tubes?

6. Instead of sales of 130,000 boxes of tubes, revised estimates show a sales volume of

161,000 boxes of tubes. At this higher sales volume, Silven would need to rent extra

equipment at a cost of \$51,000 per year to make the additional 31,000 boxes of tubes.

Assuming that the outside supplier will not accept an order for less than 161,000 boxes

of tubes, what is the financial advantage (disadvantage) in total (not per box) if Silven

buys 161,000 boxes of tubes from the outside supplier? Given this new information,

should Silven Industries make or buy the tubes?

7. Refer to the data in (6) above. Assume that the outside supplier will accept an order

of any size for the tubes at a price of \$1.95 per box. How many boxes of tubes should

Silven make? How many boxes of tubes should it buy from the outside supplier?

Part E: Relevant Cost/Sell or Process Further

Come-Clean Corporation produces a variety of cleaning compounds and solutions for

both industrial and household use. While most of its products are processed

independently, a few are related, such as the company’s Grit 337 and its Sparkle silver

polish.

Grit 337 is a coarse cleaning powder with many industrial uses. It costs \$1.60 a pound

to make, and it has a selling price of \$6.80 a pound. A small portion of the annual

production of Grit 337 is retained in the factory for further processing. It is combined

with several other ingredients to form a paste that is marketed as Sparkle silver polish.

The silver polish sells for \$5.00 per jar.

This further processing requires one-fourth pound of Grit 337 per jar of silver polish. The

additional direct variable costs involved in the processing of a jar of silver polish are:

Overhead costs associated with processing the silver polish are:

The production supervisor has no duties other than to oversee production of the silver

polish. The mixing equipment is special-purpose equipment acquired specifically to

produce the silver polish. It can produce up to 6,500 jars of polish per month. Its resale

value is negligible and it does not wear out through use.

Advertising costs for the silver polish total \$3,800 per month. Variable selling costs

associated with the silver polish are 5% of sales.

Due to a recent decline in the demand for silver polish, the company is wondering

whether its continued production is advisable. The sales manager feels that it would be

more profitable to sell all of the Grit 337 as a cleaning powder.

Required:

1. How much incremental revenue does the company earn per jar of polish by further

processing Grit 337 rather than selling it as a cleaning powder? (Round your answer

to 2 decimal places.)

2. How much incremental contribution margin does the company earn per jar of polish

by further processing Grit 337 rather than selling it as a cleaning powder? (Round your

intermediate calculations and final answer to 2 decimal places.)

3. How many jars of silver polish must be sold each month to exactly offset the

avoidable fixed costs incurred to produce and sell the polish? (Round your

intermediate calculations to 2 decimal places.)

4. If the company sells 8,700 jars of polish, what is the financial advantage

(disadvantage) of choosing to further process Grit 337 rather than selling is as a

cleaning powder? (Enter any “disadvantages” as a negative value. Round your

intermediate calculations to 2 decimal places.)

5. If the company sells 10,900 jars of polish, what is the financial advantage

(disadvantage) of choosing to further process Grit 337 rather than selling is as a

cleaning powder? (Enter any “disadvantages” as a negative value. Round your

intermediate calculations to 2 decimal places.)

Part F: Relevant Cost/Shutting Down or Continuing to Operate a Plant

Birch Company normally produces and sells 43,000 units of RG-6 each month. The

selling price is \$20 per unit, variable costs are \$10 per unit, fixed manufacturing

overhead costs total \$160,000 per month, and fixed selling costs total \$38,000 per

month.

Employment-contract strikes in the companies that purchase the bulk of the RG-6 units

have caused Birch Company’s sales to temporarily drop to only 9,000 units per month.

Birch Company estimates that the strikes will last for two months, after which time sales

of RG-6 should return to normal. Due to the current low level of sales, Birch Company is

thinking about closing down its own plant during the strike, which would reduce its fixed

manufacturing overhead costs by \$48,000 per month and its fixed selling costs by 10%.

Start-up costs at the end of the shutdown period would total \$13,000. Because Birch

Company uses Lean Production methods, no inventories are on hand.

Required:

1. What is the financial advantage (disadvantage) if Birch closes its own plant for two

months?

2. Should Birch close the plant for two months?

3. At what level of unit sales for the two-month period would Birch Company be

indifferent between closing the plant or keeping it open?