Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 47

Extensions of the CVP Analysis—Taxes

Eagle Company makes the MusicFinder, a sophisticated satellite radio. Eagle has experienced a steady growth in sales for the past five years. However, Ms. Luray, Eagle’s CEO, believes that to maintain the company’s present growth will require an aggressive advertising campaign next year. To prepare for the campaign, the company’s accountant, Mr. Bednarik, has prepared and presented to Ms. Luray the following data for the current year, Year 1:

Variable costs: Direct labor (per unit) Direct materials (per unit) Variable overhead (per unit)	$ 100.00 45.00 20.00
Total variable costs (per unit)	$ 165.00
Fixed costs (annual): Manufacturing Selling Administrative	$400,000 300,000 800,000
Total fixed costs (annual)	$1,500,000
Selling price (per unit) Expected sales revenues, Year 1 (25,000 units)	$400.00 $10,000,000

Eagle has an income tax rate of 35 percent.

Ms. Luray has set the sales target for Year 2 at a level of $11,200,000 (or 28,000 radios).

Required

a. What is the projected after-tax operating profit for Year 1?

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b. What is the break-even point in units for Year 1?

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c. Ms. Luray believes that to attain the sales target (28,000 radios) will require additional selling expenses of $300,000 for advertising in Year 2, with all other costs remaining constant. What will be the after-tax operating profit for Year 2 if the firm spends the additional $300,000?

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d. What will be the break-even point in sales dollars for Year 2 if the firm spends the additional $300,000 for advertising?

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e. If the firm spends the additional $300,000 for advertising in Year 2, what is the sales level in dollars required to equal the Year 1 after-tax operating profit?

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f. At a sales level of 28,000 units, what is the maximum amount the firm can spend on advertising to earn an after-tax operating profit of $750,000?

Step 1 of 9

a.

Prepare the income statement of E Company to calculate the after-tax operating profit for Year 1.

E Company Income Statement For the Year 1
Particulars	Amount	Amount
Sales revenue (25,000 units × $400 per unit)		$ 10,000,000
Less: Variable costs
Direct labor (25,000 units × $100 per unit)	$ 2,500,000
Direct materials (25,000 units × $45 per unit)	$ 1,125,000
Variable overhead (25,000 units × $20 per unit)	$ 500,000	$ 4,125,000
Contribution margin		$ 5,875,000
Less: Fixed costs
Manufacturing costs	$ 400,000
Selling expenses	$ 300,000
Administrative expenses	$ 800,000	$ 1,500,000
Operating profit before tax		$ 4,375,000
Less: Income tax ($4,375,000 × .35)		$ 1,531,250
Operating profit after tax		$ 2,843,750

The projected after tax operating profit for the year 1 is