Problem:
The condensed income statement for the Sally and Terry partnership for 2012 is as follows.
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SALLY AND TERRY COMPANY
Income Statement
For the Year Ended December 31, 2012
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Sales (200,000 units)
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$1,200,000
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Cost of goods sold
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800,000
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Gross profit
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400,000
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Operating expenses
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Selling
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$280,000
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Administrative
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160,000
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440,000
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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 nearest unit, dollar, and percentage, where necessary. Use the CVP income statement format in computing profits.)
(a) Compute the break-even point in total sales dollars and in units for 2012.
(b) Sally has proposed a plan to get the partnership "out of the red" and improve its profitability. She feels that 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 to only $6.25 because of competitive pressures. Sally estimates that sales volume will increase by 30%. What effect would Sally's plan have on the profits and the break-even point in dollars of the partnership? (Round the contribution margin ratio to two decimal places.)
(c) Terry 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 Sally'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. Terry quoted an old marketing research report that said that sales volume would increase by 60% if these changes were made. What effect would Terry'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.