Reference no: EM13494780

1. Calculate the variable manufacturing cost as a percentage of the selling price for each product line for 2008 and for 2010. What markup on variable manufacturing cost did the firm use to establish the selling prices for each of the three product lines in 2008? In 2010?

2. Provide the calculation that converts the wholesale selling price (WSP) of the 12/31/2008 lipstick inventory shown as $11.5 million in Schedule A of Exhibit 1 to the "cost" of $9.7 million shown in Schedule B of Exhibit 1.

3. Assuming the variable manufacturing cost per unit stayed the same in 2009 and 2010, did the sales volume of nail polish (in terms of physical units) increase or decrease after the selling price was reduced in 2010? Explain.

4. What is the firm's approximate level of annual total sales dollars required to break even in 2011?

5. Susan's proposed budget for 2011 includes a substantial repayment of the bank loan. If the repayment occurs, is the firm likely to break even in 2012? Explain. At Luxor's next executive committee meeting the proposed budget was rejected as unacceptable. The committee concluded that the bank would not grant the company a loan based on a budget showing an expected loss. The CEO summed it up succinctly, "The bank has been extremely concerned about our deteriorating situation. This budget could be the excuse they are looking for to end our relationship."

The sales manager then offered an alternative plan. "Let's undertake a vigorous advertising campaign to increase sales. If we increase our marketing and promotion budget to $3.6 million, we should be able to generate sales of $19.0 million for lipstick, $13.0 million for nail polish, and $8.0 million for the creams. That should return us to profitability."

Then he turned to you and said, "Oh, by the way, those inventory decreases in your proposed budget are unrealistic. We bring out a new range of colors every year and promote them as the current fashion. Only the new colors sell in any appreciable quantity. Thus, you need to adjust your budget to schedule production for all the products that we expect to sell." He then turned back to the committee and concluded, "I realize my plan involves some risk, but if it is successful, we will get through 2011.

I suggest we use that time to develop a bold new strategy for our long-term survival."

Prepare a new set of budgets (Income Statement, Cash Flow, and Balance Sheet) incorporating the sales manager's plan and assumptions.

A few days after you prepared the new budgets, you were having lunch in the staff room and happened to sit next to Wendy, an employee from the marketing department.

When she learned that you were the new CFO she said, "I don't understand why the fixed manufacturing costs are allocated to the product lines in proportion to the sales value of the products produced. Doesn't it make more sense to allocate fixed manufacturing costs to the three product lines in proportion to their margin of sales over variable manufacturing cost? That way we would have higher margins on our lipstick and nail polish lines."

Without doing any calculations, indicate whether the suggested change in the allocation of fixed manufacturing costs would increase, decrease, or leave unchanged next year's estimated pre-tax income. Why? Would cash flow increase, decrease, or remain the same? Why?

Because Wendy showed an interest in accounting matters, you showed her the budget based on the sales manager's predictions. "Dream on," was her response.

"Our sales people are perpetually optimistic and ignore our marketing research. Those sales volumes aren't achievable with our existing products. Our lipstick and nail polish appeals primarily to lower-income women aged 45 to 75. As these women are aging, they are buying fewer cosmetics. It is a bit morbid to say it, but we are stuck in a dying market niche."

After two weeks with Luxor, you take time to reflect on your career prospects. The challenges the firm faces seem much more difficult than you had anticipated. Further, you are not comfortable with the thought of presenting to the bank any of the budgets you have prepared. You have a lunch meeting scheduled with Mr. Luxton tomorrow.

8. What are the major issues that need addressing? Suggest some possible issues, and strategies for dealing with those issues, that you might want to discuss with the founder.