Case 9-6: Profit PlanningâChoice of CostStructure
The owner of a package delivery business is currently evaluatingthe choice between two different cost structures, based on how thedelivery personnel are paid. One option (hereafter, âAlternative#1â) has relatively higher short-term fixed costs, while the otheroption (hereafter, âAlternative #2â) has the reverseâthat is,relatively higher variable costs in its cost structure. (Forsimplicity in this example we hold the delivery cost per package,that is, the selling price per unit is constant. Selling price isindependent of the cost-structure choice.) The following tablecontains pertinent information for creating the CVP model for eachdecision alternative:
Decision Inputs (Data)
Cost Structure Alternative #1
Cost Structure Alternative #2
Delivery price (i.e., revenue) per package
$60
$60
Variable cost per package delivered
$48
$30
Contribution margin per unit
$12
$30
Fixed costs (per year)
$600,000
$3,000,000
Requirements
1. What is meant by the term âshort-term profit-planningâ model,and how can such a model be used by management? (That is, in whatsense can this model be used to facilitate planning, control, ordecision-making by managers of an organization?)
2. What are the definitions of fixed costs, variable costs,contribution margin ratio, contribution margin per unit, andrelevant range?
3. What is the break-even point, in terms of number ofdeliveries per year (or per month), for Alternative #1? ForAlternative #2?
4. How many deliveries would have to be made under Alternative#1 to generate a pre-tax profit, ÏB, of $25,000per year?
5. How many deliveries (per month or per year) would have to bemade under Alternative #1 to generate a pre-tax profit,ÏB, equal to 15% of sales revenue?
6. How many deliveries would have to be made under Alternative#2 to generate an after-tax profit, ÏA, of$100,0000 per year, assuming a tax rate of, say, 45%?
7. Assume that for the coming year total fixed costs areexpected to increase by 10% for each of the two alternatives. Whatis the new break-even point, in terms of number of deliveries, foreach decision alternative? By what percentage did the break-evenpoint change for each case? How do these figures compare to thepercentage increase in budgeted fixed costs?
8. Assume an average income-tax rate of 40%. What volume (numberof deliveries) would be needed to generate an after-taxprofit, ÏA, of 5% of sales for each alternative?
Case 9-6: Profit PlanningâChoice of CostStructure
The owner of a package delivery business is currently evaluatingthe choice between two different cost structures, based on how thedelivery personnel are paid. One option (hereafter, âAlternative#1â) has relatively higher short-term fixed costs, while the otheroption (hereafter, âAlternative #2â) has the reverseâthat is,relatively higher variable costs in its cost structure. (Forsimplicity in this example we hold the delivery cost per package,that is, the selling price per unit is constant. Selling price isindependent of the cost-structure choice.) The following tablecontains pertinent information for creating the CVP model for eachdecision alternative:
Decision Inputs (Data) | Cost Structure Alternative #1 | Cost Structure Alternative #2 |
Delivery price (i.e., revenue) per package | $60 | $60 |
Variable cost per package delivered | $48 | $30 |
Contribution margin per unit | $12 | $30 |
Fixed costs (per year) | $600,000 | $3,000,000 |
Requirements
1. What is meant by the term âshort-term profit-planningâ model,and how can such a model be used by management? (That is, in whatsense can this model be used to facilitate planning, control, ordecision-making by managers of an organization?)
2. What are the definitions of fixed costs, variable costs,contribution margin ratio, contribution margin per unit, andrelevant range?
3. What is the break-even point, in terms of number ofdeliveries per year (or per month), for Alternative #1? ForAlternative #2?
4. How many deliveries would have to be made under Alternative#1 to generate a pre-tax profit, ÏB, of $25,000per year?
5. How many deliveries (per month or per year) would have to bemade under Alternative #1 to generate a pre-tax profit,ÏB, equal to 15% of sales revenue?
6. How many deliveries would have to be made under Alternative#2 to generate an after-tax profit, ÏA, of$100,0000 per year, assuming a tax rate of, say, 45%?
7. Assume that for the coming year total fixed costs areexpected to increase by 10% for each of the two alternatives. Whatis the new break-even point, in terms of number of deliveries, foreach decision alternative? By what percentage did the break-evenpoint change for each case? How do these figures compare to thepercentage increase in budgeted fixed costs?
8. Assume an average income-tax rate of 40%. What volume (numberof deliveries) would be needed to generate an after-taxprofit, ÏA, of 5% of sales for each alternative?
Related questions
Case 9-6: Profit PlanningâChoice of CostStructure
The owner of a package delivery business is currently evaluatingthe choice between two different cost structures, based on how thedelivery personnel are paid. One option (hereafter, âAlternative#1â) has relatively higher short-term fixed costs, while the otheroption (hereafter, âAlternative #2â) has the reverseâthat is,relatively higher variable costs in its cost structure. (Forsimplicity in this example we hold the delivery cost per package,that is, the selling price per unit is constant. Selling price isindependent of the cost-structure choice.) The following tablecontains pertinent information for creating the CVP model for eachdecision alternative:
Decision Inputs (Data) | Cost Structure Alternative #1 | Cost Structure Alternative #2 |
Delivery price (i.e., revenue) per package | $60 | $60 |
Variable cost per package delivered | $48 | $30 |
Contribution margin per unit | $12 | $30 |
Fixed costs (per year) | $600,000 | $3,000,000 |
Requirements
1. Assume an average income-tax rate of 40%. What volume (numberof deliveries) would be needed to generate an after-taxprofit, ÏA, of 5% of sales for each alternative?
Case 9-6: Profit PlanningâChoice of CostStructure
The owner of a package delivery business is currently evaluatingthe choice between two different cost structures, based on how thedelivery personnel are paid. One option (hereafter, âAlternative#1â) has relatively higher short-term fixed costs, while the otheroption (hereafter, âAlternative #2â) has the reverseâthat is,relatively higher variable costs in its cost structure. (Forsimplicity in this example we hold the delivery cost per package,that is, the selling price per unit is constant. Selling price isindependent of the cost-structure choice.) The following tablecontains pertinent information for creating the CVP model for eachdecision alternative:
Decision Inputs (Data) | Cost Structure Alternative #1 | Cost Structure Alternative #2 |
Delivery price (i.e., revenue) per package | $60 | $60 |
Variable cost per package delivered | $48 | $30 |
Contribution margin per unit | $12 | $30 |
Fixed costs (per year) | $600,000 | $3,000,000 |
Requirements
1. Assume that for the comingyear total fixed costs are expected to increase by 10% for each ofthe two alternatives. What is the new break-even point, in terms ofnumber of deliveries, for each decision alternative? By whatpercentage did the break-even point change for each case? How dothese figures compare to the percentage increase in budgeted fixedcosts?
2. Assume an average income-tax rate of 40%. What volume (numberof deliveries) would be needed to generate an after-taxprofit, ÏA, of 5% of sales for each alternative?
