Managerial Accounting

Written Assignment Unit 3

You are the owner of a parasailing company that is expanding
operations to a new beachfront location, and you need to prepare a
3-year analysis for the bank that may loan you the funds to
purchase your boat and parasailing equipment. A lot of business is
done on a referral basis, where a company pays a fee to a 3rd party
to send them customers. However, because of your well-established
reputation, you already have received requests for “flights” to be
scheduled as soon as you open the new location. Therefore, you
expect to break-even the first year but must calculate the number
of flights needed. You also need to determine the new break-even
point in Year 2 if the location allows referrals, which you believe will
cost on average about 2% of the sales price overall. Finally, you
need to determine the volume needed to have $10,000 in profit in
Year 3. The following information is available:

Sales price per flight $175

Estimated loan payment per month $350
Fuel costs per flight $100
Full-time scheduler salary $2,500 per month
Boat crew per flight $30
$500 per month dock fee and use of a small office on a pier
Requirements:

Calculate the Year 1 break-even quantity, contribution margin, and

contribution margin ratio. Explain how the values were determined.
Calculate the Year 2 break-even quantity, break-even sales, and
contribution margin ratio. Explain how the values were determined.
Determine the number of flights (units) needed to retain a profit of
$10,000 in Year 3, assuming the company does allow for referrals.
Recommend if the bank should issue the loan.
Superior papers will:

Perform all calculations correctly.

Articulate the approach to solving the problem.
Explain the relationship of the costs to the concept of contribution
margin.
Discuss any limitations of the data, including what may be missing.
Conclude on whether the bank should issue the loan.
Cost Volume Profit Analysis

Synopsys

The cost volume profit analysis also referred to as CVP, is a planning

process used by management to predict future sales volume, costs
incurred, sales made and profit received. It's also a mathematical
equation that helps to compute how a change in cost and volume
will affect profit in the future ("What is Cost Volume Profit Analysis",
n.d). CVP analysis helps managers to drive decisions about what
product to sell, how much to price, etc. (Walther, L. M. & Skousen,
C.J, 2009). CVP helps in calculation break-even point in terms of
volume and numbers to achieve target income levels, and so on.
The first step in calculating all these begins with finding the
contribution margin(Walther, L. M. & Skousen, C.J, 2009).

Parasailing Company 3 year Financial Analysis

To expand operations to a new beachfront, parasailing companies

need to raise funds from banks to purchase boat and parasailing
equipment, as part of this activity, there is a need to provide three-
year financial analysis statement to the bank. Below are the
different important variable and fixed cost information considered
during financial analysis.

Sales price per flight $175

Estimated loan payment per month $350 - Fixed Cost
Fuel costs per flight $100 - Variable Cost
Full-time scheduler salary $2,500 per month - Fixed Cost
Boat crew per flight $30 - Variable Cost
$500 per month dock fee and use of a small office on the pier -
Fixed Cost

To find the total fixed cost, first, need to find the yearly expense of
all individual fixed cost i.e

Total Fixed Cost = ($350*12= $4200) + (2500*12= $30,000) +

($500*12= $6000) = $40,200 The next step is to find variable cost
per unit i.e $100 + $30 = $130. Once we know variable and fixed
cost we can calculate contribution margin and formula for the same
is Sales - variable cost

First Year Calculation

Contribution Margin(CM) = Sales ($175) - Variable cost ($130) =

$45 (Walther, L. M. & Skousen, C.J, 2009). To calculate the break-
even point in terms of numbers, first, we need to find the
contribution margin ratio and the formula for the same is:
Contribution Margin Ratio (CMR) = (Sales ($175) - Variable cost
($130) = $45) / Sales ($175) = 0.26$ or 26% (Walther, L. M. &
Skousen, C.J, 2009). For The ratio indicates the percentage of each
sales dollar that is available to cover company's fixed expense and
profit ("contribution margin ratio", n.d).

Break-even point defined as the point where total expense and total
sales are equal. Also, described as a point where there is no net
profit or loss ("Break-even Point", n.d). The formula to find Break-
Even Quantity (BEQ) = Total Fixed Cost ($40,200) / Contribution
Margin ($45) = 894 (Walther, L. M. & Skousen, C.J, 2009). The
parasailing company has to make 894 flight trips to break even in
the first year.

Second Year Calculation

To find break-even and contribution ratio for year two we shall

consider additional referral variable cost of 2% on the total sale
price. The referral variable cost = Sale per flight ($175) * 0.02 =
3.50$, This value will be added into variable cost per flight $100 +
$30 + 3.50 = $133.50 The new contribution margin, contribution
margin ratio, break-even quantity, break-even sales for year two is
as below:

Contribution Margin (CM) = Sales ($175) - Variable cost ($133.50) =

$41.50 Contribution Margin Ratio (CMR) = (Sales ($175) - Variable
cost ($133.50) = $41.50) / Sales ($175) = 0.2371$ or 23.71%
Break-Even Quantity (BEQ) = Total Fixed Cost ($40,200) /
Contribution Margin ($41.50) = 969 Break-Even Sales = Total Fixed
Cost ($40,200) / Contribution Margin Ratio($23.71) = $169,518
(Walther, L. M. & Skousen, C.J, 2009).

Third Year Calculation

To achieve a target profit of $10,000 in the third year, we shall

consider contribution margin the same as in year two i.e $41.50. To
calculate the total flights required to achieve target profit, we need
to add target value and total fixed cost and divide this by
contribution margin (Walther, L. M. & Skousen, C.J, 2009). Flights =
(Total Fixed Cost ($40,200) + Target Profit ($10,000)) / Contribution
Margin ($41.50) = 1209 Flights.

Running Head: Operations Expansion of Parasailing Company4

Contribution Margin (CM) = Sales ($175) - Variable cost ($133.50) =
$41.50 Contribution Margin Ratio (CMR) = (Sales ($175) - Variable
cost ($133.50) = $41.50) / Sales ($175) = 0.2371$ or 23.71%
Break-Even Quantity (BEQ) = Total Fixed Cost ($40,200) /
Contribution Margin ($41.50) = 969 Break-Even Sales = Total Fixed
Cost ($40,200) / Contribution Margin Ratio($23.71) = $169,518
(Walther, L. M. & Skousen, C.J, 2009). Third Year Calculation To
achieve a target profit of $10,000 in the third year, we shall
consider contribution margin the same as in year two i.e $41.50. To
calculate the total flights required to achieve target profit, we need
to add target value and total fixed cost and divide this by
contribution margin (Walther, L. M. & Skousen, C.J, 2009). Flights =
(Total Fixed Cost ($40,200) + Target Profit ($10,000)) / Contribution
Margin ($41.50) = 1209 Flights. The important data that I feel
missing before calculating contribution margin, break-even quantity
is, Company has not considered or has any target or expected sales
number for the year. Without considering/ having target sales value
it will not be possible to calculate the margin of safety, which is
essential to control the cost before the company starts losing
revenue and run into debt.

Conclusion

Because the company achieved a break-even point in the first two

years of operation, we can understand that management was able
to successfully control the cost and also they targeted to achieve a
profit of $10,000 in their third year of operation. All these factors
can be considered as positive growth. However, the contribution
margin of 23% to 26% does not look too attractive either. If the loan
amount is small I suggest a bank fund the company for their new
operations. However, before deciding on funding a bigger amount I
would suggest a bank look into other important factors like current
economic conditions, the company's future business strategies, the
outcome of management's past decision, etc.

References:

Break-even Point. (n.d.). Retrieved July 07, 2020, from

https://www.readyratios.com/reference/analysis/break_even_point.ht
ml

Contribution margin ratio definition and meaning: AccountingCoach.

(n.d.). Retrieved July 07, 2020,
fromhttps://www.accountingcoach.com/terms/C/contribution-margin-
ratio

Walther, L. M. & Skousen, C.J. (2009). Managerial and Cost

Accounting.https://library.ku.ac.ke/wp-
content/downloads/2011/08/Bookboon/Accounting/managerial-and-
cost-accounting.pdf
What is Cost Volume Profit Analysis (CVP)? - Definition: Meaning:
Example. (n.d.). Retrieved July 07, 2020,
fromhttps://www.myaccountingcourse.com/accounting-dictionary/co
st-volume- profit-analysis