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Chapter 20: 34E (page 1128)

Computing margin of safety

Robbie鈥檚 Repair Shop has a monthly target profit of \(31,000. Variable costs are 20%of sales, and monthly fixed costs are \)19,000.

Requirements

1. Compute the monthly margin of safety in dollars if the shop achieves its income goal.

2. Express Robbie鈥檚 margin of safety as a percentage of target sales.

3. Why would Robbie鈥檚 management want to know the shop鈥檚 margin of safety?

Short Answer

Expert verified
  1. If the shop achieves its income goal the margin of safety is $38,750.
  2. The margin of safety as a percentage of target sales is 62%.
  3. Margin of safety is a principle of investing that protects business against loss. Thus to maintain risk and investment managegment wants to know the margin of safety.

Step by step solution

01

Computation of Sales-

Sales=(Fixedcost+TargetprofitContributionmarginratio)=$19,000+$31,0001-0.20=$50,0000.80=$62,500

02

Computation of Break even sales-

Breakevensales=FixedexpenseContributionmarginratio=$19,0001-0.2=$19,0000.8=$23,750

03

1. Computation of Margin of safety-

Marginofsafety=Sales-Breakevensales=$62,500-$23,750=$38,750

04

2. Computation of Margin of safetyas a percentage of target sales-

Marginofsafetypercentage=MarginofsafetySales脳100=$38,750$62,500脳100=62%

05

Reason to know the shop’s margin of safety-

Margin of Safety is the quantity or the percentage of sales over the break-even sales. It is like a safety cover that protects a business against a loss. Higher the Margin of Safety, lower the risk of incurring loss on the other hand lower the Margin of Safety, higher the risk of carrying business.

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Most popular questions from this chapter

What effect does an increase in sales price have on contribution margin? An increase in fixed costs? An increase in variable costs?

No Slip Co. produces sports socks. The company has fixed costs of\(91,080 and variable costs of \)0.81 per package. Each package sells for $1.80.

Requirements

1. Compute the contribution margin per package and the contribution marginratio. (Round your answers to two decimal places.)

2. Find the breakeven point in units and in dollars using the contributionmargin approach.

Diversified Investor Group is opening an office in Boise, Idaho. Fixed monthly costs are office rent (\(8,000), depreciation on office furniture (\)1,700), utilities (\(2,400), special telephone lines (\)1,500), a connection with an online brokerage service (\(2,500), and the salary of a financial planner (\)11,900). Variable costs include payments to the financial planner (9% of revenue), advertising (11% of revenue), supplies and postage (4% of revenue), and usage fees for the telephone lines and computerized brokerage service (6% of revenue).

Requirements

  1. Use the contribution margin ratio approach to compute Diversified鈥檚 breakeven revenue in dollars. If the average trade leads to \(800 in revenue for Diversified, how many trades must be made to break even?
  2. Use the equation approach to compute the dollar revenues needed to earn a monthly target profit of \)11,200.
  3. Graph Diversified鈥檚 CVP relationships. Assume that an average trade leads to \(800 in revenue for Diversified. Show the breakeven point, the sales revenue line, the fixed cost line, the total cost line, the operating loss area, the operating income area, and the sales in units (trades) and dollars when monthly operating income of \)11,200 is earned.
  4. Suppose that the average revenue Diversified earns increases to $2,000 per trade. Compute the new breakeven point in trades. How does this affect the breakeven point?

What is contribution margin?

Question: Computing contribution margin in total, per unit, and as a ratio

Complete the table below for contribution margin per unit, total contribution margin, and contribution margin ratio:

A B C Number of units 1,720 units 14,920 units 4,620 units

Sales price per unit \( 1,800 \) 4,500 $ 5,550

Variable costs per unit 720 3,600 1,665

Calculate: 鈥冣�冣�� 鈥� 鈥冣�冣�� 鈥冣�冣�� 鈥� 鈥�

Contribution margin per unit 鈥冣�冣�� 鈥冣�冣�� 鈥� 鈥冣�冣�� 鈥冣�冣�� 鈥� 鈥�

Total contribution margin 鈥冣�冣�� 鈥冣�冣�� 鈥� 鈥冣�冣�� 鈥� 鈥冣�冣�� 鈥� 鈥�

Contribution margin ratio
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