$3-62$ CVP Operating Leverage and Margin of Safety Percentage

Miami Training Support $($MTS$)$ produces materials for companies to use for training new hires as well as advanced training for employees who have been promoted to new positions. Most of the material has been created and produced by Miami employees. There is some unique content, however, and that material differentiates the company from competitors. MST includes this content in all its courses. This content was created and produced by one of the founders of MTS$,$ who is about to leave the company. As part of the compensation agreement to be signed, MTS may continue to use the unique content but must pay the founder $($the original creator$)$ a royalty. Many of the details have been decided, but some specific issues need to be resolved. MTS is looking to you for advice on how to structure the agreement.

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Specifically, MTS is considering two options for paying the royalty. The first is course based, where MTS will pay the founder $$1,000$ for each of the courses sold. The second is a flat, annual fee of $$168,000$ for the use of the material in any of its courses. The royalty agreement will run one year and the royalty option chosen cannot be changed during the agreement. All other royalty terms are the same.

MTS charges $$5,000$ for a training course. The variable costs for a course $($excluding any royalty$)$ is $$800.$ Annual fixed costs $($excluding any royalty$)$ are $$470,000.$

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Required

a$.$ What is the annual break$-$even in terms of courses sold level assuming:

The course$-$based royalty agreement?

The flat$-$rate royalty agreement?

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b$.$At what annual volume with the operating profit be the same regardless of the royalty option chosen?

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c$.$ Suppose MTS is unsure of the pricing and costs for its costs $($other than the costs of the royalty payments under the two options$).$ At what annual volume would the operating profit be the same regardless of the royalty option chosen? If you do not have enough information to answer the question, list the additional information you would need to get from MTS$.$

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d$.$ Assume an annual volume of $300$ courses. What is the operating leverage assuming

The course$-$based royalty agreement?

The flat$-$rate royalty agreement?

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e$.$ Assume an annual volume of $300$ courses. What is the margin of safety assuming

The course$-$based royalty agreement?

The flat$-$rate royalty agreement?

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