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Management from Global Shippers Inc, an international shipping business, is in the process of assessing the choice between two different cost structures for the business
Management from Global Shippers Inc, an international shipping business, is in the process of assessing the choice between two different cost structures for the business. Option A has relatively higher variable costs per unit shipped but lower annual fixed costs, while Option B has the opposite—relatively lower variable costs in its cost structure but higher fixed costs. Assume that delivery selling prices per unit are constant. The table below contains critical information in making the decision:
Cost Information
Option A
Option B
Delivery price (revenue) per shipment
$100
$100
Variable cost per shipment delivered
$85
$60
Contribution Margin per unit
$15
$40
Fixed costs (annual)
$1,200,000
$4,500,000
Management wants you to write a professional report, answering the following questions:
Questions
1) What is the break-even point, in terms of volume (i.e., number of shipments per year), for Option A? Option B?
(2) How many shipments would have to be made under Option A to produce operating income of $30,000 for an annual period?
(3) How many shipments per year would have to be made under Option A to produce an operating margin equal to 9% of sales revenue?
(4) How many shipments are required under Option B to produce net income of $180,000 per year, given a corporate tax rate of 40%?
(5) Assume that for the coming year total fixed costs are expected to increase by 15% for each of the two options. What is the new break-even point, in terms of number of shipments, for each option? By what percentage did the break-even point change for each case? How do these figures compare to the percentage increase in budgeted fixed costs?
(6) Assume an average income-tax rate of 20%. What volume (number of shipments) would be needed to generate net income of 5% of revenue for each option?
Expert Solution
Answer:
1) Breakeven point in terms of volume:
Option A:
Breakeven point in volume = Fixed Cost / Contribution Margin
= 1,200,000/15 = 80,000
Option B:
Breakeven point in volume = 4,500,000/40 = 112,500
2) Number of Shipments to be made under Option A:
Operating Income = $30,000
X be the no. of shipments to be made,
X*Contribution Margin – Fixed Costs = Operating Profit
X*15 – 1,200,000 = 30,000
X = 1,230,000/15 = 82,000 shipments
3) No. of shipments to be made under Option A to produce an operating margin equal to 9% of sales revenue:
X*Contribution Margin – Fixed Cost = 9% * X * Delivery price per shipment
X* 15 – 1,200,000 = 9% * X * 100
15X – 1,200,000 = 9X
X = 1,200,000/6 = 200,000
4) Shipments to be made under option B to produce net income of $180,000 per year given a corporate tax of 40%:
Operating Profit = 180,000/(1-40%) = 300,000
X*Contribution Margin – Fixed Costs = Operating Profit
X*40 – 4,500,000 = 300,000
X = 4,800,000/40 = 120,000 shipments
5) New Breakeven point:
Increase in Fixed cost = 15%
Under Option A,
New Fixed cost = (1+15%) * 1,200,000 = 1,380,000
New Breakeven point = 1,380,000/15 = 92,000
% change in Breakeven = (92,000-82,000)/82,000 = 12.20%
Under Option B:
New Fixed cost = (1+15%) * 4,500,000 = 5,175,000
New Breakeven point = 5,175,000/40 = 129,375
Old Breakeven point = 4,500,000/40 = 112,500
% Change in Breakeven = (129,375-112,500)/112,500 = 15%
6) Income Tax Rate is 20%, No. of shipment to be made to generate 5% of revenue:
Under Option A:
X*Contribution Margin – Fixed costs = 5% (X*Delivery Price per shipment/(1-20%))
X*15 – 1,200,000 = 5% * X * 100 /0.8
X = 1,200,000/8.75 = 137,142.86 ≈ 137,143
Under Option B:
X*40 – 4,500,000 = 5%*X*100/0.8
X = 4,500,000/33.75 = 133,333.33 ≈ 133,334
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