Scenario: Mary Willis is the advertising manager for Bargain Shoe Store. She is currently working on a major promotional campaign. Her ideas include the installation of a new lighting system and increased display space that will add $24,000 in fixed costs to the $270,000 in fixed costs currently spent. In addition, Mary is proposing a 5% price decrease ($40 to $38) will produce a 20% increase in sales volume (20,000 to 24,000). Variable costs will remain at $24 per pair of shoes. Management is impressed with Mary's ideas but concerned about the effects these changes will have on the break-even point and the margin of safety. Compute the margin of safety ratio for current operations and after Mary's changes are introduced (Round to nearest full percent)

Instructions are below.

Explanation:

Giving the following information:

Before:

Fixed costs= 270,000

Selling price= $40

Unitary variable cost= $24

Sales in units= 20,000

After:

Fixed costs= 294,000

Selling price= $38

Unitary variable cost= $24

Sales in units= 24,000

First, we need to calculate the break-even point in units:

Break-even point in units= fixed costs/ contribution margin per unit

Before:

Break-even point in units= 270,000/ (40 - 24)

Break-even point in units= 16,875 units

After:

Break-even point in units= 294,000/14

Break-even point in units= 21,000 units

Now, the margin of safety ratio:

Margin of safety ratio= (current sales level - break-even point)/current sales level

Before:

Margin of safety ratio= (20,000 - 16,875)/20,000

Margin of safety ratio= 0.156

After:

Margin of safety ratio= 3,000/24,000

Margin of safety ratio= 0.125