Calculate break-even point and qualitative factors, Financial Accounting

Evaluating a Company's Budget Procedures

Springfield Corporation operates on a calendar-year basis.  It begins the annual budgeting process in late August, when the president establishes targets for the total dollar sales and the net income before taxes for the next year.

The sales target is given to the Marketing Department, where the marketing manager formulates a sales budget by product line in both units and dollars.  From this budget, sales quotas by product line in units and dollars are established for each of the corporation's sales districts.

The marketing manager also estimates the cost of the marketing activities required to support the target sales volume and prepares a tentative marketing expense budget.

The executive vice president uses the sales and profit targets, the sales budget by product line, and the tentative marketing expense budget to determine the dollar amount that can be devoted to manufacturing and corporate expenses, and then forwards to the Production Department the product-line sales budget in units and the total dollar amount that can be devoted to manufacturing.

The production manager meets with the factory managers to develop a manufacturing plan that will produce the required units when needed within the cost constraints set by the executive vice president.  The budgeting process usually comes to a halt at this point because the Production Department does not consider the financial resources allocated to be adequate.

When this standstill occurs, the vice president of finance, the executive vice president, the marketing manager, and the production manager meet to determine the final budgets for each of the areas.  This normally results in a modest increase in the total amount available for manufacturing costs, while the marketing expense and corporate office expense budgets are cut.  The total sales and net income figures proposed by the president are seldom changed.  Although the participants are seldom pleased with the compromise, these budgets are final.  Each executive then develops a new detailed budget for the operations in his or her area.

None of the areas has achieved its budget in recent years.  Sales often run below the target.  When budgeted sales are not achieved, each area is expected to cut costs so that the president's profit target can still be met.  However, the profit target is seldom met because costs are not cut enough.  In fact, costs often run above the original budget in all functional areas.  The president is disturbed that Springfield has not been able to meet the sales and profit targets.  He hired a consultant with considerable experience with companies in Springfield's industry.  The consultant reviewed the budgets for the past four years.  He concluded that the product-line sales budgets were reasonable and that the cost and expense budgets were adequate for the budgeted sales and production levels.

Springfield Express is a luxury passenger carrier in Texas. All seats are first class, and the following data are available:

Number of seats per passenger train car

90

Average load factor (percentage of seats filled)

70%

Average full passenger fare

$160

Average variable cost per passenger

$70

Fixed operating cost per month

$3,150,000

  1. What is the break-even point in passengers and revenues per month?
  2. What is the break-even point in number of passenger train cars per month?
  3. If Springfield Express raises its average passenger fare to $ 190, it is estimated that the average load factor will decrease to 60 percent. What will be the monthly break-even point in number of passenger cars?
  4. (Refer to original data.) Fuel cost is a significant variable cost to any railway. If crude oil increases by $ 20 per barrel, it is estimated that variable cost per passenger will rise to $ 90. What will be the new break-even point in passengers and in number of passenger train cars?
  5. Springfield Express has experienced an increase in variable cost per passenger to $ 85 and an increase in total fixed cost to $ 3,600,000. The company has decided to raise the average fare to $ 205. If the tax rate is 30 percent, how many passengers per month are needed to generate an after-tax profit of $ 750,000?
  6. (Use original data). Springfield Express is considering offering a discounted fare of $ 120, which the company believes would increase the load factor to 80 percent. Only the additional seats would be sold at the discounted fare. Additional monthly advertising cost would be $ 180,000. How much pre-tax income would the discounted fare provide Springfield Express if the company has 50 passenger train cars per day, 30 days per month?
  7. Springfield Express has an opportunity to obtain a new route that would be traveled 20 times per month. The company believes it can sell seats at $ 175 on the route, but the load factor would be only 60 percent. Fixed cost would increase by $ 250,000 per month for additional personnel, additional passenger train cars, maintenance, and so on. Variable cost per passenger would remain at $ 70.
    1. Should the company obtain the route?
    2. How many passenger train cars must Springfield Express operate to earn pre-tax income of $ 120,000 per month on this route?
    3. If the load factor could be increased to 75 percent, how many passenger train cars must be operated to earn pre-tax income of $ 120,000 per month on this route?
    4. What qualitative factors should be considered by Springfield Express in making its decision about acquiring this route?
Posted Date: 3/7/2013 1:46:39 AM | Location : United States







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