Accounting 102, Recitation Session 01

Solution

Part 1
Mr. Reilly Big owns and operates Big Electronics, a retail electronics store. Reilly is trying to
determine the amount of display space to be allocated to each of the four brands of High Definition
Televisions (HDTV) that he currently sells. To effectively display a brand of HDTV requires a
minimum of 9 square feet of display space (= 1 display unit) and Reilly has a total of 11 display units
(99 square feet) available to be allocated. His current contract with his supplier requires that he
allocate at least 1 display unit (9 square feet) to each brand. Data for each brand of HDTV is given
below:
LG

Sony

Mitsubishi

Pioneer

Selling price per HDTV

$2,000

$2,100

$1,750

$1,800

Variable cost per HDTV

$1,400

$1,600

$1,000

$1,275

18

14

12

HDTVs sold per week per

display unit (9 sq ft)
Maximum number of HDTVs
that could be sold per week

Required:
1.

(7 points)

If Reilly allocates the available display space optimally (satisfying the terms of his
contract with the supplier), what is the maximum contribution margin that he can
earn per week?
Maximum weekly contribution margin that Reilly can earn
by allocating the available shelf display space optimally
$

12,350

LG

Sony

Mitsubishi

Pioneer

Contrib. Margin

2,000 1,400 = 600

2,100 1,600 = 500

1,750 1,000 =750

1,800 1,275 = 525

CM/display unit

600 x 1 =

500 x 1 =

750 x 2 =

525 x 2

Rank (hi to lo)

Display Units
Allocated
Total CM

600

4
1

600 x 1 =

500

600

1
1

500 x 1 =

1,500

500

1,050
2

4
1,500 x 4 =

6,000

5
1,050 x 5 =

5,250

Accounting 102, Recitation Session 01

2.

(4 points)

Solution

For a fee of $500 per week, Reillys supplier will remove the minimum display space
requirement from the contract. If the requirement is removed, Reilly can sell any of
the four brands that he chooses and he can allocate the available display space as he
chooses. Should Reilly pay the supplier to remove the requirement? (To receive full
credit, you must provide computations to support your answer.)
Reilly

SHOULD

pay to remove the space requirement.

If the restrictions were removed Reillys contribution margin would be

Allocate 4 display units to Mitsubishi ==>
Allocate 5 display units to Pioneer
==>
Allocate 1 display unit to LG
==>

CM = 1,500 x 4 =
C M = 1,050 x 6 =
CM=

Less cost of removing restriction

Since 12,400 > 12,350 = Contribution margin with restriction,

Reilly should pay to have the restriction removed.

6,000
6,300
600
12,900
( 500)
12,400

Accounting 102, Recitation Session 01

Solution

Part 2
1.

(3 points)

In 2013, HOV Inc.s margin of safety was $80,000 based on sales revenues totaling
$200,000. For the year, the companys average contribution margin ratio was 20%.
What was HOVs fixed cost in 2013?
HOVs fixed cost in 2013

24,000

Breakeven sales = Sales Margin of Safety

= 200,000 80,000
= 120,000
Fixed Costs

2.

(4 points)

= Breakeven sales x Contribution Margin Ratio

= 120,000 x 20%
= 24,000

Old Money Corp. produces and sells two products. The Brake, with variable
production and selling costs of $30 per unit, is sold at a price of $50 per unit; the
Morell is sold at a price of $60 per unit and has variable costs amounting to $50 per
unit. The companys fixed costs total $2.8 million.
Assume that for every Morell unit, the company typically sells three Brake units. At
breakeven, what are the expected total variable costs for the production and sale of
Morells?
Expected total variable costs for Morells at breakeven

2,000,000

Let the breakeven sales of Brakes and of Morells be B units and M units,
respectively. Then,
B = 3M
And,
[(50 30) x 3M] + [(60 50) x M] = 2,800,000
M =

2,800,000
= 40,000 units
(20 x 3) + 10

Total variable costs at breakeven = 40,000 x 50

= 2,000,000

Accounting 102, Recitation Session 01

Solution

Use the following data to answer questions 4 and 5:

Interslope, a record label, sells high quality concert recordings at a price of $120 each. The total
variable cost per record, including royalty fees paid to the recording artists, amounts to $40. The
companys total fixed costs amount to $1,008,000, annually. Currently, Interslopes income tax
rate is 40%.

4.

(3 points)

If the company wants to earn an after-tax income amounting to $345,600 for the
upcoming year, how many recordings must it sell?
Sales volume required to earn after-tax income of $345,600

Contribution Margin

5.

(4 points)

= 120 40

19,80
0

units

= 80

Target pre-tax income = 345,600 / (1-0.4)

= 576,000

Required Sales

= 19,800

= (1,008,000 + 576,000) / 80

Interslopes recording artists have threatened to sue the company over the royalty
fees it pays to them. To avoid the law suit, Interslope is considering two courses of
action. One possibility under consideration is to increase the royalty fee paid to the
recording artist from $4 to $9 per recording. The other possibility being considered
is to pay a lump sum amount of $100,000 to the artists labor association. Assuming
that Interslope wants to maintain its after-tax income at $345,600, which alternative
should it choose? Circle the correct answer and provide your reasoning below.
Increase royalty
fees

Pay lump sum amount

Increased Royalties:
Required Sales = (576,000 + 1,008,000) / (80 - (9-4))

= 21,120

Lump sum:
Required Sales

= 21,050

= (( 576,000 + (1,008,000 + 100,000)) / 80

The lower sale volume needed to maintain profitability is better for the firm.