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Handout for Multiple Products and Sales Mix

So far, we have focused on a single product case. We now consider the case in
which the firm produces and sells two products. Our discussion can be easily
extended to the case in which the number of the products is more than two.

Let a company produce and sell two products, 1 and 2. We can compute the
weighted average unit contribution margin as follows.

q1 q2
WAUCM = UCM1 x q1 + q2 + UCM2 x q + q
1 2

WAUCM is an indicator of the average profitability of current sales mix.

Similarly, we compute the weighted average contribution margin ratio by

S1 S2
WACMR = CMR1 x + CMR 2 x
S1 + S 2 S1 + S 2

As in a single product case, we have

FC
BE Quantity = QB = WAUCM

FC
BE Sales = SB = WACMR .

It is important that the BE quantity and sales in the above formulas denote the total
number of units and sales dollars of product 1 and product 2, assuming the same
sales mix. Thus, to know the component of each product, we need to consider the
relative proportion. That is,

q1 q2
q1B = QB x q + q and q2B = QB x q + q .
1 2 1 2

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In-Class Problem for CVP Analysis

Frutex. Inc has two products, Fantasy and Joy. Current cost and sales data on two
products are:
Fantasy Joy
Unit Price $15 $100
Variable expense/unit 9 20
Annual sales quantity 20,000 5,000

Fixed expenses total $475,800 per year.

1. Assuming the sales mix given above.

a. Prepare a contribution I/S showing both dollar and percent columns


for each product and for the company as a whole.
b. Compute the BEP in quantity and sales for the company.

Another product, Samoan Delight, has just come onto the market. Assume that the
company can sell 10,000 units at $45 each. The variable expenses would be $36
each, and the there is no change in the fixed expenses.

2a. Prepare a contribution I/S showing both dollar and percent columns for each
product and for the company as a whole.
2b. Compute the BEP in sales for the company.

The president of the company says, “There is something strange here! Our fixed
costs haven’t changed, and the company has greater contribution margin if the new
product is added. But your analysis shows that the break-even point in sales goes
up. With a greater contribution margin, BEP should go down, not up. I don’t
understand.

2c. Explain to the president what has happened.

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Answer:

1a. Fantasy Joy Total


Amount % Amount % Amount %
Sales 300,000 100 500,000 100 800,000 100
VC 180,000 60 100,000 20 280,000 35
CM 120,000 40 400,000 80 520,000 65
FC 475,800
NI 44,200

1b. UCMF = 15 - 9 = 6
UMCJ = 100 - 20 = 80

WAUCM = 6 x [20,000 / 25,000] + 80 x [5,000 / 25,000] = 20.8

QB = 475,800 / 20.8 = 22875

 qFB = 22875 x [20,000 / 25,000] = 18,300 units


qJB = 22875 x [5,000 / 25,000] = 4,575 units

SB = $15 x 18300 + $100 x 4,575 = $732,000

Note that SB can be computed by FC / WACMR = 475,800 / .65

2a. Fantasy Joy Delight Total


Amount % Amount % Amount % Amount %
Sales 300,000 100 500,000 100 450,000 100 1,250,000 100
VC 180,000 60 100,000 20 360,000 80 640,000 51.2
CM 120,000 40 400,000 80 90,000 20 610,000 48.8
FC 475,800
NI 134,200

2b. SB = 475,800 / .488 = $975,000

2c. The president’s statement is incorrect since the BEP does not go down when CM increases.
Recall that BEP in sales is computed by FC / WACMR, and WACMR has been decreased from 65% to
48.8%. The reason is that Delight has a lower CMR, 20%, compared to Joy and Fantasy, which causes the
average profitability of company to decrease per dollar of sales.

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Multiple Products & Sales Mix (Alternative Method)

Sales Mix is a combination of products.

Example:

Essie owns a dress shop. She can purchase dresses for $32 from
a local factory; other variable costs amount to $10 per dress.

Assume that the selling price per dress is $70 and total fixed
costs amount to $84,000.

⇒ p = 70, v = 32 + 10 = 42, FC = 84,000

$70 – $42 = $28 unit contribution margin (ucm).

Essie considers selling blouses, whose variable cost per blouse


equals $9. This will not require any additional fixed costs. She
expects to sell 2 blouses at $20 each for every dress it sells.

Packaged in a box

1 dress | 2 blouses

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What is the new breakeven point (in terms of dresses and
blouses)?

The contribution margin per dress is

$28 (⇐ $70 – $42).

The contribution margin per blouse is $20 – $9 = $11.


⇒ The contribution margin of the mix (package) is

1 × $28 + (2 × $11) = $28 + $22 = $50.

$84,000 fixed costs ÷ $50 = 1,680 packages

1,680 × 2 = 3,360 blouses


1,680 × 1 = 1,680 dresses
Total units = 5,040

What is the breakeven point in dollars?

1,680 × 2 = 3,360 blouses × $20 =$ 67,200


1,680 × 1 = 1,680 dresses × $70 = 117,600
$184,800

How many units of dresses and blouses can achieve the target
profit of $16,000?

(84000 + 16000) / 50 = 2000 packages


⇒ 2000 × 1 = 2000 dresses
2000 × 2 = 4000 blouses.

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Case 6-32 (75 minutes)

Before proceeding with the solution, it is helpful first to restructure the data into
contribution format for each of the three alternatives. (The data in the statements below
are in thousands.)
15% 20%
Commission Commission Own Sales Force
$16,000.
Sales $16,000 100% $16,000 100% 0 100.0%
Variable expenses:
Manufacturing 7,200 7,200 7,200.0
Commissions (15%, 20% 1,200.
7.5%) 2,400 3,200 0
8,400.
Total variable expenses 9,600 60 10,400 65 0 52.5
7,600.
Contribution margin 6,400 40% 5,600 35% 0 47.5%
Fixed expenses:
Manufacturing overhead 2,340 2,340 2,340.0
Marketing 120 120 2,520.0 *
Administrative 1,800 1,800 1,725.0 **

Interest 540 540 540.0


7,125.
Total fixed expenses 4,800 4,800 0
Income before income taxes 1,600 800 475.0
Less income taxes (30%) 480 240 142.5
Net income $ 1,120 $  560 $  332.5

© The McGraw-Hill Companies, Inc., 2008. All rights reserved.


Solutions Manual, Chapter 6 6
*$120,000 + $2,400,000 = $2,520,000.
**$1,800,000 – $75,000 = $1,725,000.

© The McGraw-Hill Companies, Inc., 2008. All rights reserved.


Solutions Manual, Chapter 6 7
Case 6-32 (continued)

1. When the income before taxes is zero, income taxes will also
be zero and net income will be zero. Therefore, the break-even
calculations can be based on the income before taxes.

a. Break-even point in dollar sales if the commission remains


15%.
Fixed costs $4,800,000
= =$12,000,000
CM ratio 0.40
b. Break-even point in dollar sales if the commission increases
to 20%.
Fixed costs $4,800,000
= =$13,714,286
CM ratio 0.35
c. Break-even point in dollar sales if the company employs its
own sales force.
Fixed costs $7,125,000
= =$15,000,000
CM ratio 0.475

2. In order to generate a $1,120,000 net income, the company


must generate $1,600,000 in income before taxes. Therefore,
Dollar sales to= Fixed expenses + Target income before taxes
attain target CM ratio
$4,800,000 + $1,600,000 $6,400,000
= = = $18,285,714
0.35 0.35

3. To determine the volume of sales at which net income would


be equal under either the 20% commission plan or the
company sales force plan, we find the volume of sales where
costs before income taxes under the two plans are equal.
X = Total sales revenue
0.65X +
$4,800,000 = 0.525X + $7,125,000
0.125X = $2,325,000
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X = $2,325,000 ÷ 0.125
X = $18,600,000

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Case 6-32 (continued)

Thus, at a sales level of $18,600,000 either plan would yield


the same income before taxes and net income. Below this sales
level, the commission plan would yield the largest net income;
above this sales level, the sales force plan would yield the
largest net income.

4. a., b., and c.


15% 20% Own
Commissio Commissi Sales
n on Force
Contribution margin (Part 1)
(x) $6,400,000 $5,600,000 $7,600,000
Income before taxes (Part 1)
(y) $1,600,000 $ 800,000 $ 475,000
Degree of operating
leverage:
(x) ÷ (y) 4 7 16

5. We would continue to use the sales agents for at least one


more year, and possibly for two more years. The reasons are as
follows:
First, use of the sales agents would have a less dramatic
effect on net income.
Second, use of the sales agents for at least one more year
would give the company more time to hire competent people
and get the sales group organized.
Third, the sales force plan doesn’t become more desirable
than the use of sales agents until the company reaches sales
of $18,600,000 a year. This level probably won’t be reached
for at least one more year, and possibly two years.
Fourth, the sales force plan will be highly leveraged since it
will greatly increase fixed costs (and decrease variable
costs). One or two years from now, when sales have reached
the $18,600,000 level, the company can benefit greatly from
this leverage. For the moment, profits will be greater and
risks will be less by staying with the agents, even at the
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higher 20% commission rate.

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