If Mirabel invests the additional $650,000 in fixed marketing expenses, sales of the Model 301 are expected to increase by 8%. What is the break-even and margin of safety under these circumstances? If the projection is that sales will increase by 10% in the coming year, can the company afford to also increase commission from 12% to 15%? Why or why not. Assume that sales volume remains fixed but there is a 5% increase in variable expenses (materials cost) for the Model 101 and 301 and a 10% increase in variable expenses for Model 201. What is the new break-even?
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 | |||
| 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)
- If Mirabel invests the additional $650,000 in fixed marketing expenses, sales of the Model 301 are expected to increase by 8%. What is the break-even and margin of safety under these circumstances?
- If the projection is that sales will increase by 10% in the coming year, can the company afford to also increase commission from 12% to 15%? Why or why not.
- Assume that sales volume remains fixed but there is a 5% increase in variable expenses (materials cost) for the Model 101 and 301 and a 10% increase in variable expenses for Model 201. What is the new break-even?
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