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The condensed income statement for the Terri and Jerry partnership for 2008 is as follows: Terri and Jerry Company Income statement For the year ended December 31, 2008 Sales (200,000 units) $1,200,000 Cost of goods sold 800,000 Gross Profit &n bsp; 400,000 Selling expenses $280,000 Administrative Expenses 160,000 440,000 Net loss &nbs p; (40,000) A cost behavior analysis indicates that 75% of the cost of goods sold are variable, 50% of the selling expenses are variable, and 25% of the administrative expenses are variable. Instructions (Round to the nearest unit, dollar, and percentage, where necessary. Use the cost volume profit income statement format in computing profits.) (a) Compute the break even point in total sales, dollars, and in units for 2008. (b) Terri has proposed a plan to get the partnership “out of the red” and improve its profitability. She feels the quality of the product could be substantially improved by spending $0.25 more per unit on better raw materials. The selling price per unit could be increased only $6.25 because of competitive pressures. Terri estimates that sales volumes will increase by 30%. What effect would Terri’s plan have on the profits and the break even point in dollars of the partner ship? (Round the contribution margin ratio to two decimal places.) (c) Jerry was a marketing major in college. He believes that sales volume can be increased only by intensive advertising and promotional campaigns. He therefore proposed the following plan as an alternative to Terri’s. (1) Increase variable selling expenses to $0.79 per unit, (2) lower the selling price per unit by $0.30, and (3) increase fixed selling expenses by $35,000. Jerry quoted an old marketing research report that said that sales volumes would increase by 60% if these changes were made. What effect would Jerry’s plan have on the profits and the break-even point in dollars of the partnership? (d) Which plan should be accepted? Explain your answer in a 1 page double-spaced paper explaining the problem and the solution. Pretend that the person reading it knows absolutely nothing about accounting or finance. Solution (a) The variable costs per unit are: Cost of goods sold ($600,000 ÷ 200,000) ................................................. Selling expenses ($140,000 ÷ 200,000) .................................................... Administrative expenses ($40,000 ÷ 200,000) ........................................ Total ................................................................................................ Fixed Costs are: Cost of goods sold ($800,000 X .25) ........................................................ Selling expenses ($280,000 X .50) ........................................................... Administrative expenses ($160.000 X .75) ............................................. $3.00 .70 .20 $3.90 $200,000 140,000 120,000 $460,000 The break-even points are: X = ($3.90 ÷ $6.00) X + $460,000 X = .65X + $460,000 .35X = $460,000 X = $1,314,286 (rounded) $6.00X = $3.90X + $460,000 $2.10X = $460,000 X = 219,048 units (rounded) (b) Variable unit cost of goods sold = $3.25 ($600,000 ÷ 200,000 = $3.00; $3.00 + $.25) Sales volume = 260,000 units (200,000 X 130%) Total sales = 260,000 X $6.25 = $1,625,000 Net income computation: Sales ............................................................................ Variable expenses Cost of goods sold ............................................. (260,000 X $3.25) Selling expenses ................................................ (260,000 X $.70) Administrative expenses (260,000 X $.20) ........................................... Total variable expenses.......................... Contribution margin .................................................. Fixed expenses $1,625,000 $845,000 182,000 52,000 1,079,000 546,000 Cost of goods sold ............................................. Selling expenses ................................................ Administrative expenses .................................. Total fixed expenses ............................... Net income .................................................................. $200,000 140,000 120,000 460,000 $ 86,000 X = ($1,079,000 ÷ $1,625,000)X + $460,000 X = .66X + $460,000 .34X = $460,000 X = $1,352,941 (rounded) Profits and the break-even point would both increase. (c) Sales [320,000 (1) X ($6.00 – $.30)] ..................................... Variable expenses Cost of goods sold ....................................................... (320,000 X $3.00) Selling expenses (320,000 X $.79) ............................. Administrative expenses (320,000 X $.20) ..................................................... Total variable expenses.................................... Contribution margin ............................................................ Fixed expenses Cost of goods sold ....................................................... Selling expenses .......................................................... ($140,000 + $35,000) Administrative expenses ............................................ Total fixed expenses ......................................... Net income ............................................................................ $1,824,000 $960,000 252,800 64,000 1,276,800 547,200 $200,000 175,000 120,000 495,000 $ 52,200 (1) Sales volume = 200,000 X 160% = 320,000 X = ($1,276,800 ÷ $1,824,000)X + $495,000 X = .70X + $495,000 .30X = $495,000 X = $1,650,000 Profits and the break-even point would both increase. (d) Terri’s plan should be accepted. It produces a higher net income and a lower break-even point than Jerry’s plan