1. a.

The variable expenses are 36% of sales or $97.20 so the contribution margin is $172.80. The numerator of the target profit equation adds fixed costs of $4,400 and target profit of $1,200 and the denominator is the contribution margin per unit. The CM per unit is $172.80 per unit calculated by subtracting the variable expenses of $97.20 from the sales price of $270. The target profit is ($4,400+$1,200)¸ $172.80 per unit.

2. d.

The breakeven in snowboards is calculated by dividing the fixed expenses of $5,000 by the CM of $167.40.

3. a.

The breakeven sales can be computed by dividing fixed expenses of $6,000 by the CMR of 60%. Breakeven sales are $10,000. The CMR is 100% sales less the 40% variable costs percentage.

4. c.

The target sales equation is fixed expenses plus target profit divided by the contribution margin ratio is equal to target sales. ($10,000+$2,000) ¸ 45% = $22,222.

(Hint: If you are unsure of how to do the math- just substitute the four choices in the correct equation to see if one of the answers fits.)

5. b.

To compute the target sales needed to obtain an after tax profit of $8,000, you need to first divide the after tax profit of $8,000 by 100% less the tax rate of 40% or 60% to get the amount of profit required on a before tax basis. In this case the before tax profit needed is $13,333. To calculate target sales, add fixed costs of $16,000 to the before tax profit of $13,333 and divided that sum by the CMR of 45%. The CMR was calculated by first determining that the variable costs were 55% of sales so the CM must be 45% (must add to 100%).

6. c.

Correct. Assuming that fixed expenses stay within the relevant range, profit should increase by $2,520 calculated by multiplying the CMR of 63% times the increase in sales of $4,000.

7. b.

To compare its results with corporate forms of business in the same industry the Lovejoy Company should subtract a reasonable salary for the owner from the net income. The reason for this is that in a sole proprietorship, the owner does not record a salary expense for the work he/she puts in the business. Therefore the profit must not only include a return on the investment but also compensate the owner for the many hours of long work. In a corporation, any owners who work in the business are paid salaries and the expense for that work is included on the income statement. To make the ROE of the two different forms of business comparable, Lovejoy should calculate the ROE by dividing the net income of $98,000 less the reasonable salary of $38,000 by the average owner’s equity of $300,000.

8. a.

The correct computation is to divide the net income of $76,000 by the average stockholders’ equity of $636,000. The fact that only $56,000 of the net income had been received in cash is irrelevant. Students also need to ignore the comment about the salaries of the stockholders. The average equity of $636,000 can be computed by adding the beginning equity of $598,000 and the ending equity of $674,000 and dividing by two. The ending equity is computed by adding the beginning equity of $598,000 and the net income of $76,000. If there were any dividends they would have been subtracted from net income.

9. a.

Correct. The target profit after tax is equal to the target profit before tax times (1 – tax rate) so the equation for this problem is after tax profit of $120,000 = profit before tax ´ (1 – 35%) or $120,000 = .65 ´ before tax profit. Mathematically, $120,000 divided by .65 will give us the correct answer of $184,615

10. b.

Given that the company expects that this increase in marketing will cause a $10,000 increase in sales, regardless of the department advertised, the company should focus its advertising on Department D as it has the highest contribution margin ratio and therefore will provide the most dollars to covering fixed expenses and generating a profit. The contribution margin ratio is calculated by dividing the contribution margin by sales. The CMRs for Departments A, B, C, and D are 14.00%, 25.83%, 23.64% and 29.23% respectively.