Mirabel Manufacturing is a small but growing company that manufactures and sells marine sonar equipment. They employ a national sales force and their primary customers are marine retailers and boat dealerships. The company has expanded over the last 5 years and Paul Mirabel, the founder, and CEO has become concerned that he no longer has a clear picture of their cost structure. He calls his CFO, Mary Jane Montgomery in for a meeting.
“Mary Jane, I am concerned that I am not current on our cost structure and how that is impacting our bottom line,” Paul begins.
“Well, Paul, the company has grown considerably over the past 5 years, so I’m not surprised that you feel a little disconnected with how things are going,” Mary Jane replied. She continued “In fact, I’ve been meaning to talk to you about a couple of big items such as increasing the sales commission to 15%. We’ve lost two of our best account managers in the last 9 months. It seems like we are behind the curve paying only 12% on gross sales.”
“What do you mean we are behind the curve,” Paul replied angrily. “We have always been the leader in every aspect of our business.”
“Well, that may have been the case in the past, Paul, but frankly we need to step up our compensation package to stay competitive,” Mary Jane replied. She continued, “And that’s not everything. I met with Frank Jacobs from marketing and he said we need to have a bigger presence at the trade show in March. He told me he would need about $650,000 added to the marketing budget to support new marketing materials.”
“Come on, Mary Jane, how can we do that when we are going to have to increase commission?” He continued, “I spoke with Dan Clark in production and he indicated that we have two pieces of equipment that need to be replaced by the end of the quarter and that’s going to set us back almost $1.2 million.”
Mary Jane shook her head. “Paul, I hate to bring this up but while we are talking costs, but Bob in purchasing stopped by the office and dropped off some revised cost information – it looks like several of our suppliers are talking about significant price increases by the end of the year.”
Paul slumped in his chair. “This is a mess, Mary Jane. Increasing commissions, new equipment, materials price increases, and marketing expenses all at once. Even if Frank Mallow is correct that we should see a 10% increase in sales for the coming year, I just don’t see how we can make this work. We have to maintain enough profit to keep the shareholders happy and I can’t sleep when we dip below that $2 million margins of safety.”
Mary Jane gathered up her papers. “Before you get too distressed, let me put together some figures and let’s see what this looks like on paper. I’ll get back to you by the end of the week. In the meantime, stay positive, we’ll find the best solution.”
The following income and cost data for Mirabel is provided:
| Mirabel Manufacturing | |||
| Budgeted Income Statement | |||
| For the Year Ending December 31 | |||
| Sales | $ 36,750,000 | ||
| Cost of goods sold: | |||
| Variable | $ 13,300,000 | ||
| Fixed | $ 9,300,000 | ||
| Gross Margin | $ 14,150,000 | ||
| Selling & Administrative | |||
| Commissions | $ 4,410,000 | ||
| Fixed Marketing Expenses | $ 1,350,000 | ||
| Fixed Administrative | $ 6,000,000 | ||
| Net Operating Income | $ 2,390,000 |
| Model 101 | Model 201 | Model 301 | |
| Normal Annual Sales Volume | 16,000 | 19,000 | 11,000 |
| Unit Selling Price | $ 650 | $ 750 | $ 1,100 |
| Variable expense per unit | $ 250 | $ 200 | $ 500 |
(Note: Each of the following questions is independent of the others)
Report:
report from Mary Jane to Don explaining how these changes will affect Mirabel’s overall cost structure. For those changes that are controllable, make a recommendation considering the uncontrollable cost changes. Be certain to consider not only the company’s break-even point but also the desired margin of safety.
Mirabel Manufacturing is facing a critical juncture as it grapples with various cost-related challenges that have emerged due to its recent growth. In this report, we will analyze the company’s current cost structure and evaluate the impact of proposed changes on its break-even point and margin of safety. We will also discuss the feasibility of these changes in the context of a projected 10% increase in sales.
Overall Break-Even Point: Mirabel’s overall break-even point in sales dollars can be calculated by summing up the fixed costs (Commissions, Fixed Marketing Expenses, Fixed Administrative) and then dividing them by the contribution margin ratio (CMR).
Fixed Costs = Commissions + Fixed Marketing Expenses + Fixed Administrative Fixed Costs = $4,410,000 + $1,350,000 + $6,000,000 = $11,760,000
Contribution Margin Ratio (CMR) = (Gross Margin) / (Sales) CMR = $14,150,000 / $36,750,000 ≈ 0.3855
Break-Even Point = Fixed Costs / CMR Break-Even Point = $11,760,000 / 0.3855 ≈ $30,481,509
Therefore, Mirabel’s overall break-even point in sales dollars is approximately $30,481,509.
If Mirabel increases the sales commission to 15%, the fixed costs will remain the same, but the variable cost associated with commissions will increase. This change will affect the break-even point and margin of safety.
Increasing Commissions to 15% will increase variable costs for commissions:
New Commissions = 15% * Sales = 0.15 * $36,750,000 = $5,512,500
New Break-Even Point = (Fixed Costs + New Commissions) / CMR New Break-Even Point = ($11,760,000 + $5,512,500) / 0.3855 ≈ $42,272,512
Margin of Safety = (Sales – New Break-Even Point) / Sales Margin of Safety = ($36,750,000 – $42,272,512) / $36,750,000 ≈ -14.95%
Increasing the sales commission to 15% will increase the break-even point to approximately $42.27 million and result in a negative margin of safety of around 14.95%. This change may not be feasible unless accompanied by significant sales growth.
If Mirabel purchases new equipment for $1,200,000, it will increase fixed costs by 10% but decrease variable costs per unit for all three models by 5%.
New Fixed Costs = Existing Fixed Costs + Equipment Cost Increase New Fixed Costs = $11,760,000 + 10% * $1,200,000 = $11,760,000 + $120,000 = $11,880,000
New Variable Expense per Unit = Existing Variable Expense per Unit – 5% New Variable Expense per Unit for all Models: Model 101: $250 – 5% * $250 = $237.50 Model 201: $200 – 5% * $200 = $190.00 Model 301: $500 – 5% * $500 = $475.00
New Break-Even Point = (New Fixed Costs) / CMR New Break-Even Point = $11,880,000 / 0.3855 ≈ $30,764,418
The purchase of new equipment will slightly decrease the break-even point to approximately $30.76 million.
Investing an additional $650,000 in fixed marketing expenses is expected to increase sales of Model 301 by 8%. Let’s calculate the break-even and margin of safety under these circumstances.
New Sales for Model 301 = 11,000 units * 108% = 11,880 units
New Contribution Margin for Model 301 = (Unit Selling Price – New Variable Expense per Unit) * New Sales for Model 301 New Contribution Margin for Model 301 = ($1,100 – $475) * 11,880 = $7,560,600
New Break-Even Point = (New Fixed Costs) / CMR New Break-Even Point = $12,230,000 / 0.3855 ≈ $31,697,318
Margin of Safety = (Sales – New Break-Even Point) / Sales Margin of Safety = ($36,750,000 – $31,697,318) / $36,750,000 ≈ 13.71%
With the increased marketing expenses, the break-even point is approximately $31.70 million, and the margin of safety is around 13.71%.
New Sales = 110% * $36,750,000 = $40,425,000
New Commissions at 15% = 15% * $40,425,000 = $6,063,750
New Break-Even Point = (New Fixed Costs + New Commissions) / CMR New Break-Even Point = ($11,880,000 + $6,063,750) / 0.3855 ≈ $46,718,430
Margin of Safety = (New Sales – New Break-Even Point) / New Sales Margin of Safety = ($40,425,000 – $46,718,430) / $40,425,000 ≈ -15.56%
With a projected 10% sales increase and a 15% commission rate, the break-even point would be approximately $46.72 million, resulting in a negative margin of safety of around 15.56%. This change may not be feasible without substantial sales growth.
New Variable Expense per Unit for Model 101 = $250 * 105% = $262.50 New Variable Expense per Unit for Model 301 = $500 * 105% = $525.00 New Variable Expense per Unit for Model 201 = $200 * 110% = $220.00
New Break-Even Point = (New Fixed Costs) / CMR New Break-Even Point = $11,760,000 / 0.3855 ≈ $30,481,509
The break-even point remains the same at approximately $30.48 million despite the increase in variable expenses.
Mirabel Manufacturing is facing a complex set of challenges in managing its cost structure. Several proposed changes, such as increasing commissions and marketing expenses, have a significant impact on the break-even point and margin of safety. These changes may not be feasible without substantial sales growth. Purchasing new equipment, on the other hand
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