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3- calculate breakeven point ?

PROBLEM 8-35
Surreal Sound, Inc. manufactures and sells compact disks. Price and cost data are as follows:
Selling price per unit (package of two CDs) $ 25.00
Variable Costs per unit:
Direct Materials $ 8.20
Direct Labour 4.00
Manufacturing Overheads 6.00
Selling Expenses 1.60
Total Variable Costs per Unit $19.80
Annual Fixed Costs
Manufacturing Overheads $288,000
Selling & Administrative Overheads 414,000
Total Fixed Costs $ 702,000
Forecasted Annual Sales Volume (140,000 units) $ 3,500,000

Required:
1 What is Surreal‟s break even point in units?
2 What is the company‟s break even point in sales dollars?
3 How many units would Surreal Sound have to sell in order to earn $
390,000?
4 What is the firm‟s margin of safety?
5 Management estimates that direct labour costs will increase by 10% next year.
How many units will the company have to sell next year to reach its break even
point?
6 If the company‟s direct labour costs do increase by 10 percent, what selling
price per unit of product must it charge to maintain the same contribution
margin ratio?

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fixed costs
1. Break - even point (in units) 
unit contribution margin
$702,000
  135,000 units
$25.00  $19.80
fixed cost
2. Break - even point (in sales dollars) 
contribution - margin ratio
$702,000
  $3,375,000
$25.00  $19.80
$25.00

fixed costs  target net profit

3. Number of sales units required to 
earn target net profit unit contribution margin
$702,000  $390,000
  210,000 units
$25.00  $19.80
4. Margin of safety = budgeted sales revenue – break-even sales revenue
= (140,000)($25) – $3,375,000 = $125,000

5. Break-even point if direct-labor costs increase by 10 percent:

New unit contribution margin = $25.00 – $8.20 – ($4.00)(1.10) – $6.00 – $1.60

= $4.80
fixed costs
Break-even point 
new unit contribution margin
$702,000
  146,250 units
$4.80
unit contribution margin
6. Contribution margin ratio 
sales price
$25.00  $19.80
Old contribution-margin ratio 
$25.00
 .208

Let P denote sales price required to maintain a contribution-margin ratio of .208. Then
P is determined as follows:

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P  $8.20  ($4.00)(1.10)  $6.00  $1.60

 .208
P
P  $20.20  .208P
.792P  $20.20
P  $25.51(rounded)
Check: New contribution- $25.51  $8.20  ($4.00)(1.10)  $6.00  $1.60

margin ratio $25.51
 .208 (rounded)

4- budgeting for sales , production & direct material

April
April May
May June
June Quarter
Quarter

Budgeted
Budgeted
sales
sales (units)
(units) 20,000
20,000 50,000
50,000 30,000
30,000 100,000
100,000
Selling
Sellingprice
price
per unit
per unit $$ 10
10 $$ 10
10 $$ 10
10 $$ 10
10
Total
Total
Revenue
Revenue $$200,000
200,000 $$500,000
500,000 $$300,000
300,000 $$1,000,000
1,000,000

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Production Budget

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Direct-Material Budget

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April May June Quarter

April May June Quarter
Production in units 26,000 46,000 29,000 101,000
Production in units 26,000 46,000 29,000 101,000
Materials per unit 5 5 5 5
Materials per unit 5 5 5 5
Production needs 130,000 230,000 145,000 505,000
Production needs 130,000 230,000 145,000 505,000
Add: desired
Add: desired
ending inventory 23,000 14,500 11,500 11,500
ending inventory 23,000 14,500 11,500 11,500
Total needed 153,000 244,500 156,500 516,500
Total needed 153,000 244,500 156,500 516,500
Less: beginning
Less: beginning
inventory 13,000 23,000 14,500 13,000
inventory 13,000 23,000 14,500 13,000
Materials to be
Materials to be
purchased 140,000 221,500 142,000 503,500
purchased 140,000 221,500 142,000 503,500

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5- Net present value

CASE 16-57
The Board of Education for the Blue Ridge School District is considering the acquisition
of several minibuses for use in transporting students to school. Five of the school
district‟s bus routes are under populated, with the result that the full size buses on those
routes are not fully utilized. After a careful study, the board has decided that it is not
feasible to consolidate these routes into fewer routes served by full size buses. The area
in which the students live is too large for that approach, since some students‟ bus ride to
school would exceed the state maximum of 45 minutes.
The plan under consideration by the Board is to replace five full size buses with eight
minibuses, each of which would cover a much shorter route than a full size bus. The
bus drivers in this rural school district are part time employees whose compensation costs
the school district $ 18,000 per year for each driver. In addition to the drivers‟
compensation, the annual costs of operating and maintaining a full size bus amounts to $
50,000. In contrast, the board projects that a minibus will cost only $ 20,000 annually to
operate and maintain. A minibus driver earns the same wages as a full size bus driver.
The school district controller has estimated that it will cost the district $ 15,250, initially,
to redesign its bus routes, inform the public, install caution signs in certain hazardous
locations, and retrain its drivers.
A minibus costs $ 27,000, whereas a full size bus costs $ 90,000. The school district
uses straight line depreciation for all of its long lived assets. The Board has two options
regarding the five full size buses. First, the buses could be sold now for $ 15,000 each.
Second, the buses could be kept in reserve to use for field trips and out-of-town athletic
events and to use as back up vehicles when buses break down. Currently, the Board

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charters buses from a private company for these purposes. The annual cost of chartering
buses amounts to $ 30,000. The school district controller has estimated that this cost
could be cut to $ 5,000 per year if the buses were kept in reserve. The five full size
buses have five years of useful life remaining, either as regularly scheduled uses or as
reserve buses. The useful life of a new minibus is projected to be five years also.
Blue Ridge School District uses a hurdle rate of 12 percent on all capital projects.

Required
a) Think about the decision problem faced by the Board of Education. What are
the board‟s two main alternatives?
b) One of these main alternatives has two options embedded within it. What are
those two options?
c) Suppose the Board of Education chosses to buy the minibuses. Prepare a net
present value analysis of the 2 options for the 5 full size buses. Should these
buses be sold or kept in reserve?
d) From your answer to „3‟ , you know the best option for the board to choose
regarding the full size buses if the minibuses are purchased. Now you can
ignore the other option. Prepare the net present value analysis of the school
board‟s two main alternatives : (a) continue to use the full size buses on a
regular routes, or (b) purchase the minibuses. Should the minibuses be
purchased?
e) Compute the internal rate of return on the proposed minibus acquisition.
f) What information given in this case was irrelevant to the school board‟s
decision problem? Explain why the information s irrelevant.
g) Independent of requirements „a” to „f‟, suppose the NPV analysis favours
keeping the full size buses. Michael Jeffries, the Business Manager for the
Blue Ridge School District, was prepared to recommend that the board not
purchase the minibuses. Before doing so, however, Jeffries ran into a long-
time friend at the racquet club. Peter Renolds was the Vice president for
sales at a local automobile dealership from which the minibuses would have
been purchased. Jeffries broke the bad news about his impending
recommendation about the minibuses to his friend. The two talked for some
time about the pros and cons of the minibus alternative. Finally, Reynolds
said, “Michael, you and I go back a long time. I know you are not paid all
that well at the school district. Out top financial person is retiring next year.
How would you like to come to work for the dealership/‟
“That‟s pretty tempting, Peter. Let me think it over,” was Jeffries‟ response.
“Sure, Michael, take all the time you want. In the meantime, how about
rethinking that minibus decision” It‟s no big deal to you, and I could sure use
the business.”
“But Peter, I told you what the figures say about,” responded Jeffries.

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“Cone on Michael. What are friends for/‟

Discuss the ethical issues in this situation. What should Michael Jeffries do?

1. The two main alternatives for the Board of Education are as follows:
(a) Use full-size buses on regular routes
(b) Use minibuses on regular routes
2. If the board decides to use minibuses, then there are two options for the full-
size buses:
(a) Sell them
(b) Keep them in reserve
3. Net-present-value analysis of options for full-size buses:
(a) Sell five full-size buses:
$75,000*
Sales proceeds ($15,000  5) ................................................................................
*No discounting necessary, since the buses would be sold now (time 0).

(b) Annual savings on bus charter fees ($30,000 – $5,000) ..................................... $25,000
Annuity discount factor (Table IV: r = .12, n = 5) ................................................
 3.605
Present value of savings .......................................................................................
$90,125
The full-size buses should be kept in reserve, since the NPV of that option
is greater.

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